China’s Renminbi Declines After Being Named a Global Currency, Posing Challenges

23 Dec 2015 | Author: | No comments yet »

As Fed fog lifts, central bankers keep puzzling over China.

HONG KONG — At the end of last month, the Chinese renminbi was anointed as one of the world’s elite currencies, a first for an emerging market and a widely hailed acknowledgment of China’s rising financial influence and economic might. The world’s central banks are scrambling to assess the risk a slowing China poses to their economies and appear to be no closer than most other observers to working out what is going on in the world’s second largest economy.

The yuan halted its longest losing streak on record amid speculation China’s central bank is seeking to avoid one-way depreciation bets at a time of rising capital outflows.LONDON – The Nobel laureate Robert Mundell once said, “great powers have great currencies.” China, whose government Mundell long advised, seemed to take this notion to heart, prodding the International Monetary Fund for years to add the renminbi to the basket of currencies that determine the value of the IMF’s reserve asset, the Special Drawing Right (SDR).

But soon after reaching that milestone, the renminbi started slowly and steadily falling as Chinese companies and individuals moved huge sums of money out of the country’s weakening economy. The drops of the past two weeks were “only a market phenomenon spawned by expectations of the rate hike” by the Federal Reserve, the official Xinhua News Agency said in a commentary on Thursday. And now the IMF has decided to do just that, in what amounts to a huge vote of confidence in China’s capacity to play a major role in international finance. It added that the Chinese economy’s strength will prevent the yuan from dropping too far. “The yuan has been in its gradual decline because of the U.S. rate hike,” said Daniel Chan, a Hong Kong-based analyst at Brilliant & Bright Investment Consultancy Ltd. “Now that the Fed has moved, it’s time for China to make sure market expectations on the yuan aren’t one-sided toward depreciation as that could risk accelerating capital outflows.” The yuan climbed 0.03 percent to close at 6.4815 a dollar in Shanghai, according to China Foreign Exchange Trade System prices. While a weaker currency helps the country’s exporters, the government must also control the slide, or risk fanning market worries and trade tensions.

By raising interest rates on Wednesday the Fed removed one major source of uncertainty, leaving developments in China at the top of investors’ and policymakers’ watch lists, alongside the Fed’s next steps. Brilliant and Bright’s Chan expects the yuan, which has retreated 0.4 percent this week, to fall by as much as 3 percent by June 30 in a “gradual manner” as the dollar strengthens. It also reflects the market’s bet that the currency will continue to fall as the Chinese government looks to help the country’s economy by making exporters more competitive. In Hong Kong’s free market, the offshore yuan slipped 0.05 percent on Friday and retreated 0.5 percent for the week to 6.5644 a dollar, according to data compiled by Bloomberg.

Economists have questioned China’s economic statistics for years and turned to measures such as concrete, steel or electricity production to get a handle on an economy that has grown almost 10 per cent a year for 30 years. The gap between the onshore and offshore yuan’s spot rates exceeded 0.08 a dollar — 800 so-called pips — on Wednesday before suspected intervention by the PBOC in the offshore market. If the renminbi falls too steeply, the volatility could prompt traders to place large bets on further depreciation, making the decline harder to control. The issue, according to Fed insiders, former Fed employees and economists is that while the Group of Seven top industrial nations share a common policy language and well established communications channels, they are less developed at the Group of 20.

A large pool of offshore renminbi that is freely convertible for trade payment and investment also exists — Hong Kong being the largest offshore center with some RMB 1 trillion in funding. Neither does the People’s Bank of China send policymakers to international economic meetings where they could mingle with top officials from the Fed, ECB, BOJ and other central banks. Financial institutions including the PBOC sold 221 billion yuan ($34 billion) of foreign exchange in November, a sign of capital outflows, data showed this week. The renminbi offshore bond market amounts to just 0.5% of the world’s total, with 40% issued in dollars, 41% in euros, nearly 10% in pounds, and 2% in yen.

In an effort to meet the I.M.F. requirements, China had to loosen some of its currency controls, making it somewhat more susceptible to market forces. The renminbi may not yet be freely convertible, but the developments so far reinforce the view that the renminbi is on track for full convertibility within the next few years.

An examination by Reuters shows the Fed relies on the same publicly available China data that other economists do, and U.S. central bankers acknowledge both publicly and privately that they cannot say they have any firmer handle on how shifts in the Chinese economy affect the United States than anyone else. And the renminbi accounts for 0.6-1% of global foreign-exchange reserves held by central banks, whereas the dollar and the euro account for 62% and 23%, respectively. Also, it will also give greater confidence to companies and institutions around the world to settle trade in renminbi and invest in renminbi-denominated assets. The Fed, for its part, is now churning out at least one paper on China each month, compared with only three or four a year a decade ago, a Reuters analysis shows. Indeed, like most developing countries, China remains an “immature creditor” that lends mainly in dollars; and if it needed to borrow in international markets, it would have to issue most of its debt in dollars, not renminbi.

That is not counting the unpublished policy briefings and internal modelling that insiders say inform decisions, such as the Fed’s September call to keep rates on hold. Central banks and reserve managers who hold assets denominated in SDRs, or who match their reserves to the SDR, will need to adjust their renminbi holdings accordingly. The I.M.F. had said that China has adopted substantial reforms aimed at making the renminbi more “freely usable.” The Treasury accepted this in lending American support to the decision by the I.M.F.’s board to accept the renminbi. In the run-up to the IMF’s twice-a-decade review of the SDR basket composition, policymakers in Beijing had stepped up financial reforms in a bid to attain inclusion.

Furthermore, Chinese leaders are determined to push through reforms – especially of the banking sector and state-owned enterprises – that will help drive forward this development. In August, the authorities gave market forces a greater role in how the central parity rate of the renminbi against the US dollar’s daily trading band is determined. San Francisco Fed President John Williams, who makes an annual swing through Asia with Board Governor Jerome Powell, has said his meetings with Chinese officials give him greater confidence the authorities there will engineer a smooth transition from an export-led economy to a domestically driven one, even if that pivot is faster than expected. Their approach – based on the belief that a more diversified, and thus more liquid, international monetary system would contribute to a more balanced and less volatile global economy – is more pragmatic.

While lower lending rates have helped housing prices and construction by making mortgages cheaper, lower rates on bank deposits have also given an extra incentive for Chinese investors to look overseas for opportunities. A Shenzhen-Hong Kong equivalent of the Shanghai-Hong Kong Stock Connect, which allows investors from both sides direct access to each other’s market, is in the works. Major currency policy decisions, including the decision to let the renminbi sink steadily lower against the dollar, are made by Communist Party leaders, leaving the central bank to manage day-to-day interventions in the markets. So is a scheme that will start allowing retail investors in mainland China to invest overseas, and could unleash billions of renminbi in Chinese savings onto global stock, bond and real estate markets.

The quotas that currently cap the amount of foreign capital that can flow into China via an array of cross-border investment channels could be raised further, and could ultimately even be abolished. As China seeks to rebalance its economy towards more consumption, services and higher-value manufacturing, it needs a more open capital account: liberalization will help support economic growth, improve the allocation of capital, and help bring down borrowing costs. But the mere fact that it will happen at the G-20, rather than at the long-dominant G-7, sends a clear message that the global economic and monetary system is changing for good. China is enforcing its remaining regulations much more stringently this autumn, in an attempt to choke off more speculative outflows into overseas real estate and other investments. Paola Subacchi, Research Director of International Economics at Chatham House, is the author of the forthcoming book The People’s Money: How China Is Turning the Renminbi into a World Currency (Columbia University Press).

An official news outlet, People’s Daily, reported last month that the authorities had closed an underground bank that had handled illegal foreign exchange transactions totaling $64 billion, mainly money leaving the country, since the start of 2013. The global financial system needs to get ready for a fundamental change —and for the imminent arrival of a new player in the form of a rapidly internationalizing renminbi. Zhang Zepeng, the sales manager at the Qingdao Reliance Refrigeration Equipment Company, which makes cold-storage rooms and refrigerator compressors in Qingdao, has profited from a weaker renminbi on its exports.

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