Chinese
yuan’s devaluation warranted by Economic fundamentals and
Can’t
be accused of unleashing currency war:more tremors are likely
D
SAMBANDHAN
S
HARIKUMAR
For long, China
has been accused of artificially manipulating its currency value to maintain an
undervalued currency to boost exports and thus gain favourable employment benefits.
If you look at the Yuan vs USD nominal exchange rate since the major
devaluation that took place in 1994 it almost stayed put till 2005 around the
magic rate of say 8.28 RNB per the USD.
Short
lived exchange rate flexibility
For a long-time the central Bank of
China had been intervening heavily in the foreign exchange market and purchasing dollars and
accumulating the reserves to prevent the Chinese currency from appreciating and also creating a cushion to
fall back upon in the event of crisis.
It did not bother about
the inherent risk of rising inflation
underlying the intervention, consequent upon the dollar purchase in the market
through the injection of the domestic currency.
As if responding to the
main criticism that china, the strong economy was operating with a weak
currency and that it was refusing to revalue even while the economic fundamentals
were dictating that, it agreed to introduce sufficient exchange rate
flexibility in2005 by moving away from the traditional dollar peg and towards
the basket peg. The exchange rate did appreciate for a while before settling
down at 6 plus in2014.The story of the currency script has changed dramatically
in the last two years following dip in exports and the consequent slowing down
of growth.
This was the time when
the Chinese economy that has been growing at phenomenal two digit level for a
significantly long period largely through managed exchange rate policy and
enormous consumer appetite of the west did come to a halt below that double
digit rate in the first half of 2011 and declined further down, thereafter
until it touched less than 7% in 2015.
Rise
of the USD and escalation in
Real
effective exchange rate of RNB
It must be underlined
here that despite some semblance of exchange rate flexibility during this phase
(2011-2014), the exchange rate policy was tied with the US monetary policy and
tacitly linked with dollar. Its side effects were inflation, rising wages and
later a prolonged real appreciation in the real effective exchange rate and Bela
Balassa and Samuelsson’s and other effects of rising productivity helped
compensate for the loss of export competitiveness.
With the US dollar
rising sharply in the recent times and euro, yen and other Asian currencies
falling under the weight of dollar, Chinese growth slowing down, her
merchandise trade balance also shrinking and becoming problematic, stock market
in trouble because of the government excessive intervention and making it
behave in their images and eventually capital flowing out to the tune of $800
billion China felt the heat.
Inadequate
devaluation of RNB
A
Pre-emptive Move to Tame the market
And before the market
took any upper hand it preferred to pre-empt that move and thus came the two
stage devaluation as an symbolic act but making big noise given the fact that
the one of the largest exporters/ consumers of raw materials and inputs in the
world market was in deep trouble creating fear of one more round of serious
recession.
In a Strategic
move, on 11 August 2015 PBC decided to
consider the previous day’s interbank closing rate as benchmark to fix central
parity, this was essentially aimed at 2
% depreciation of RMB against USD. The same exercise was continued, on 12
August 2015, for fixing central parity facilitating further depreciation of 1.5
per cent.
The two consequent and unexpected devaluation
of Yuan by People’s Bank of China (PBC), though not much significant in
percentage terms, made a big noise and has jolted the market that was
recovering from Greek Crisis. As the migrant issue raises public upheaval in politically polarised
Europe and despite the Federal Reserve
System contemplating on ending
accommodative interest rate policy has chosen not to do so and stayed put, the miseries of financial market
is far from over particularly for emerging economies as the tremors of Chinese
action will have a spillover for a while.
Action
on the Monetary front
By
easing Interest rate
After achieving the desired result PBC through
orchestrated effort along with state run banks, anchored the currency at the
desired level, frustrating further downward spiralling expectations of market
forces. However, the GDP growth officially accepted at 7 per cent and export
growth decelerating Chinese authorities again had to act this time on monetary
front. On 26 August 2015, PBC reduced the bench mark loan and deposit rates by
0.25 % and also slashed the deposit reserve ratio by 0.50 % with effect from
Sept 6, 2015 to give up fillip to falling domestic growth.
Under
the circumstances, China’s case for Devaluation and Ideal marriage with low interest
can’t be faulted, as the script has changed now and
therefore it cannot be termed as the competitive devaluation. with the enhanced strength of the US dollar the
china’s currency value has also gone up;
it is not just the bilateral dollar exchange rate has risen but also the
RMB real effective exchange rate has also appreciated. Furthermore, the policy
initiative behind the move of the central bank also stems from the problems in
the stock market and thus wants it to be activated by low interest rate.
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Besides
the policy initiative to have a devalued exchange rate ,the ideal marriage
with the soft interest regime has been
ushered in to help ensure the economy
to march on a” path of cyclical recovery and achieve the growth target
of around 7 percent.”This cannot be
faulted,e And
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The Chinese economic
miracle will not dramatically reverse; however the slowdown presents a major
predicament for Central banks across the world both of developed and emerging
economies. European Central Bank (ECB) was bewildered by the latest lower than
estimated growth and inflation figures of Euro-area and stated its willingness
to continue asset purchase programme beyond September 2016 deadline in the
context of evolving developments in global exchange rate front. Stanley Fisher,
Vice Chairman of Federal Reserve System in his address, at the prestigious
Jackson Hole Symposium (29 August), while dissecting the various domestic and
international factors that hold US Inflation rates has emphasised the relevance
of developments in China in monetary decision making process. The same echo was
audible in G-20 meeting in Ankara (4-5 September 2015) where the Finance
Ministers and Central bank Governors pledged to refrain from competitive
devaluation.
The global economic
actors particularly of emerging economies
are now gravely concerned primarily about lack of Chinese demand and
drying up of capital flows with hot capital seeking safe haven with possibility
of imminent US interest rate hike in the near future. The fall in oil price
essentially due to fall in demand this time has a disturbing dual impact,
destabilising the economic prospects of oil exporting nations and rising
deflationary threats to the developed countries. The shrinking Chinese demand
would be severe blow to economies like South Africa, Brazil and other Latin
American-the economies that have huge dependency on commodity export. Southeast
Asian economies with close knit trade relations with China would be rattled by
any unfavourable currency alignment by China.
China and emerging economies have now a sigh
of relief as the expected rise in interest rate by the FED has been deferred and
factored in the fragile equilibrium of global economy. The
writing on the wall is clear, unless global central banks follow a concerted
and accommodative interest rate and exchange rate policy stance, the global
economy will sooner or later will slip into further recessionary mood.
Latest
policy Directive from PBC
(SEPT 19 2015 )To arrest Speculation
Before we conclude it
must be underlined that the recent strategic devaluation to surprise the market
as an intimidatory tactic is inadequate
and the market is ripe with
currency speculation.A child in the womb economics ( our term) would tell
you that fixed exchange rate and easy
monetary policy do not go well especially when the currency speculation is
rife in the market. China is aware of this.
Market had already
factored in about the imminent devaluation by way of increase in short term
position in FX Forward market by more than 200%( indicating currency
speculation) as compared to the average between January and july 2015
.Imposition of new reserve requirements as a part of macro prudential measures
requiring banks deposit with the PBC 20% of short position in FX derivative
contracts with the nonbank clients (towards option and swap) but not
applying them to foreign central banks, Sovereign Wealth Funds and
international Financial Institutions is viewed as a form of capital control. This
merry go round cannot go for ever.
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D Sambandhan is a professor in International
Economics and former DEAN of school of social sciences and international
studies, Pondicherry central university and S Harikumar is a Delhi based
professional banker. Feedbacks can be sent to dsambandhan @ gmail. com
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