First published: 11th August 2015
The big news out of China overnight was that the People Bank of China lowered its daily fix by 1.9%. What this means in practice is a mini-devaluation.
The PBC normally fixes the exchange rate daily, adjusting for currency demand and supply, and allows it to fluctuate by 2% in either direction. In addition now though, the PBC will reference the prior day’s closing rate. The window dressing here is that the RMB is becoming more market-driven, and that the PBC will open up the market further and gradually unify the on-shore and off-shore exchange rates.
That’s as may be but there is little that disguises the authorities’ move as policy easing in the face of weakening exports, the hiatus in growth, the rising expectations of higher US policy rates, and the sharp decline in EM exchange rates. In fact, while the RMB has been roughly stable since the middle of last year when the EM currency rout started, its effective value has shot up by nearly 15% this year alone.
I was a bit surprised about the timing bearing in mind the authorities’ desire to portray currency stability as a key calling card for the SDR review that is due later this year. It isn’t clear if the IMF’s decision to defer the effective start date of any change until September 2016 has played any role in China’s fx decision, but I’d wager that while the RMB will now continue to be managed lower agains the US dollar – I now expect a rate of around 6.70 by year end – it is hard to imagine that China will embark on a more substantial devaluation and damage its bona fides in the eyes of the IMF Board.
Nevertheless, look at the backdrop against which the decision has been made. This is the fourth consecutive year of slowing economic growth in which stimulus measures have been found necessary. At mid-year, there were some signs that floorspace sold in the real estate sector and fixed asset investment had stabilised, but we have seen this before and it is unlikely that the secular fade in real estate and non-infrastructure investment is going to reverse.
The failure of the strategy to ramp the stock market and spur a shift in the capital structure of SOEs from debt to equity financing, the existence of chronic overcapacity in real estate and heavy industries, a decline in the investment rate and in exports, spreading deflation (July’s PPI was -5.2% over a year ago), and rising indebtedness constitute the main factors that are forcing the pace of policy easing. Prior to the RMB announcement, policy banks, like China Development Bank, were authorised to issue a further RMB 1 trillion of bonds to finance new infrastructure. July bank lending at RMB1.48 trillion was twice as high as market expectations. For the first seven months of 2015, bank lending of RMB8.o4 trillion was 36% up on the same period a yar ago. Even though total social financing was RMB718 billion, appreciably lower than in June, it was a good 40% up on a year ago. Other policy easing measures announced in recent months span local government financing conditions, PBC pledged supplementary lending, declines in interest rates and reserve requirement ratios, and fiscal and regulatory initiatives.
The bottom line is that China has succumbed finally to exchange rate depreciation, but not yet, I think, to a specific or substantial devaluation that would destabilise global financial markets or run the risk of China being complicit in starting a new currency war. It remains very likely that China’s SDR aspirations, and fears of triggering further large capital outflows will keep the authorities cautious and constrained about exchange rate depreciation.
But make no mistake. China’s currency policy has crossed the Rubicon. The consequences have not been lost on other Asian currencies, such as those of Australia, New Zealand, Singapore and S. Korea. Expect them and the EM currency universe to watch and follow the RMB much more closely now.