Give up ambition to turn renminbi into an international currency. Let it float!
China should let the renminbi float
JANUARY 10, 2017 by: Guest writer The few weeks between the beginning of 2017 and the Chinese new year may be used by the Chinese monetary authorities to tweak some policies. The exchange rate is an area in desperate need of reform. Will China finally embrace the market and let the renminbi float? Despite the ambition to turn it into an international currency – i.e. a currency used to invoice and settle international trade, and to be held as an asset – the renminbi remains a currency with limited international demand. Why? Because the exchange rate against the dollar remains a target of policy intervention. Recent reforms of the exchange rate arrangements have delivered more flexibility and have limited the scope for policy intervention and for tampering with the daily fix.
However, this has proved not to be enough at times of high volatility – as it has been the case since August 2015. As a result, the People’s Bank of China (PBoC), China’s central bank, has continued to manage the exchange rate, fearing that more market-oriented arrangements would exacerbate volatility. To some extent the PBoC’s inability to let the exchange rate float and be set by the interaction between supply and demand epitomises China’s seemingly irreconcilable options: to continue trying to manage the economy or to follow through on their various plans to build a more market-oriented system. But, as many China observers know, reforms and opening up are a complex process of experimentation under controlled conditions – for example the free trade zones – and gradual implementation. Existing interests, political tangles and the objective issue of stability turn financial and monetary reforms into a more complex process than it has ever been the case for the real economy. But ‘crossing the river by feeling the stones’ – China’s default policy approach – combined with a great deal of ‘kicking the can down the road’ now seems increasingly untenable vis-a-vis the exchange rate. The shift in the US monetary policy and the relative strength of the dollar have pushed the PBoC between a rock and a hard place. The dollar is now a more attractive asset for Chinese investors who are always searching for yield, and strong demand for dollars will continue to push the value of the renminbi below the lower limit of the fluctuation band, forcing the PBoC to sell dollars in order to prop up the value of the Chinese currency. The effects of this interventions are evident in the drop in the official foreign exchange reserves to the current US$3tn from the peak of about US$4tn in summer 2014. Along with the financial costs of managing the exchange rates there are increasing political costs. The new Trump administration is likely to embrace the narrative of China as a currency manipulator that was a prominent feature of the US-China relations in the pre-financial crisis years. It does not make sense for China to risk starting the relationship with the new US administration on a potentially hostile note for the sake of defending a below par policy. So, the best course of action would be to stop market interventions and let the renminbi float. But in order to make this work it would be necessary to manage capital movements and contain the impact of excessive outflows on the exchange rate. The PBoC calls this system ‘managed convertibility’ or capital account liberalisation ‘Chinese style’ where financial opening is achieved through quotas and licenses. So far ‘managed convertibility’ hasn’t been ineffective at calibrating the intensity of capital movements. To fix a porous system and rein in capital controls is challenging both at the operational level – i.e. measures to be implemented – and the market level. But this seems to be the road chosen by the authorities as recent measures such as requirements for more paperwork for individuals keen to purchase up to US$50,000 worth of foreign exchange suggest. Of course one should wonder why a country with a large trade surplus – approximately US$600bn in the year to November 2016 – has ended up with a weakening currency. Besides the fact that the Chinese economy is growing at a slower rate than just a few years ago, and this makes investing in China less desirable, it is the system of financial repression and unreformed governance that is talking a toll on the currency. Having the option, many Chinese prefer to take some of their savings elsewhere. In n December more than 55 per cent of a sample of Chinese retail investors had plans to invest at least 10 per cent of their assets in foreign exchange. Until domestic financial reforms are fully implemented, firmer capital controls to ‘manage convertibility’ while the exchange rate is left free to float are necessary to make the renminbi more than a token international currency. Paola Subacchi is Director of International Economics Research at Chatham House. Her book on the renminbi, The People’s Money, has been published by Columbia University Press. Back to beyondbrics
ft.com |
