China Under Pressure on Currency Policy

An analysis by Michael Lelyveld
2016-02-08
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Fang Xinghai (R), vice chairman of the China Securities Regulatory Commission, discusses a new approach to managing the yuan's value against a basket of currencies with International Monetary Fund managing director Christine Lagarde at the World Economic Forum in Davos, Switzerland, Jan. 21, 2016.
Fang Xinghai (R), vice chairman of the China Securities Regulatory Commission, discusses a new approach to managing the yuan's value against a basket of currencies with International Monetary Fund managing director Christine Lagarde at the World Economic Forum in Davos, Switzerland, Jan. 21, 2016.
AFP

Concerns are rising over China's management of its currency policies as its economic growth rate declines.

Speaking at the World Economic Forum in Davos, Switzerland, on Jan. 21, the International Monetary Fund's managing director, Christine Lagarde, chided China for sending mixed signals during its downshift to sustainable development and slower growth.

"I would say also that given those massive transitions that are undertaken pretty much at the same time and accepted as such, there is a communication issue," said Lagarde, according to The New York Times. "It's something that markets do not like."

Lagarde's unusually blunt criticism might have been aimed at China's frequent rule changes for stock market trading, as well as its fickle foreign exchange rate regime.

The remarks came during a panel discussion with Fang Xinghai, vice chairman of the China Securities Regulatory Commission (CSRC), who outlined a new approach to managing the yuan's value against a basket of currencies instead of the U.S. dollar alone.

Since the People's Bank of China (PBOC) announced a switch to the basket as its reference in December, its daily decisions on the exchange rate have been "hard to decipher," The Wall Street Journal said.

Speaking at the forum on Jan. 23, Lagarde again called for greater "clarity and certainty" on China's exchange rate management, "in particular with reference to the dollar, which has always been the reference."

The comments quoted by Reuters suggested that Lagarde did not buy China's explanation that it was basing the yuan's value on the new currency basket and leaving the dollar peg behind.

At the beginning of January, the PBOC abruptly devalued the yuan by 1.5 percent against the dollar in its daily "midpoint fixings" without explanation, throwing stock markets at home and abroad into a spin.

Two days later, Premier Li Keqiang said there was "no basis" for depreciation and denied the PBOC was deliberately driving the yuan down to cheapen its exports.

On Jan, 27, the official Xinhua news agency repeated the assurance in stern terms.

"China does not have a policy to devaluate the yuan over the long term," it said. "China, as a responsible player, has promised not to carry out competitive devaluation to stimulate its export. This is a commitment."

Lack of transparency

But the early January move bore a striking resemblance to a similar 1.9-percent drop in the currency's fixings last Aug. 11, which the central bank has yet to fully explain.

The lack of transparency has left domestic and foreign investors with a host of uncertainties.

Was the PBOC guiding the yuan lower in response to international pressures or to attempt to get ahead of steeper declines?

Was it managing against the new currency basket or the stronger dollar? Was it reacting to greater-than-reported economic weakness and stock market scares or defending the currency as it intervened with more liquidity?

As the crisis dragged on, the sequence of events argued against any single reason behind the PBOC's daily decisions, which appeared to be driven by an accelerating spiral of rising concerns.

"Until there is more certainty over what's going on in China, it's better to stay away," one New York-based asset manager told The Wall Street Journal in Davos.

Poor communication may be at the heart of the uncertainties over China.

In an interview, Harvard University economics professor Dale Jorgenson said that China should be working more closely with the IMF to improve its policy responses and transparency.

"They should be taking advice from the International Monetary Fund, and I think Christine Lagarde is a very good place to start," he said.

Jorgenson praised the Chinese officials at Davos for being receptive to criticism, but he added that the next step should be to "accelerate the learning process" in consultation with the IMF.

"This is something the Chinese need to do," he said.

On Jan. 28, Xinhua reported that Premier Li had talked with Lagarde by phone, but it made a point of saying that the contact was "upon her request."

According to the account, Li again vowed that China "has no intention of boosting exports by devaluing the yuan," insisting that the exchange rate has stayed "basically stable against a basket of currencies."

The IMF planned to "step up communication and cooperation with China to jointly convey to the market the commitment to reform and confidence in growth," Lagarde reportedly said.

A major step

The IMF took a major step toward China in November when it approved the yuan for inclusion in its Special Drawing Rights basket of currencies, along with the U.S. dollar, the euro, Japan's yen and the British pound. But doubts have dogged the yuan and China's foreign exchange policies ever since.

Jorgenson said the sequence of daily fixings and devaluation decisions has been "very confusing."

Some of China's troubles may stem from attempts to deflate its stock market bubble with tighter monetary policies before the crash last year, resulting in a series of heavy-handed interventions that whipsawed markets with contradictory signals.

Jorgenson said the PBOC should not be in the business of managing results on China's thinly-traded stock exchanges at all.

"They need to stop focusing their attention on that," he said.

On Saturday, the PBOC released a quarterly report, pledging to continue "prudent monetary policy" and "fine tune policy in a timely manner." The largely boilerplate language gave few clues about what the bank would do next.

But China's crisis may already have gone too far for regulators to control it only with more communication and minding their monetary business.

On Jan. 26, Reuters reported that a group of foreign hedge funds have placed bets against the yuan, expecting a massive devaluation of 20 to 50 percent against the dollar in the near term.

The speculators hope to duplicate the challenge mounted by legendary currency trader George Soros, who made his fortune in 1992 by betting that the Bank of England would be unable to defend the value of the British pound.

"China has an opportunity now to allow a very sharp devaluation. The wise move would be to do it quickly," Reuters quoted one fund manager as saying.

"If they wait to see if things change, they will be doing it increasingly from a position of weakness. That's how you invite the speculators," said Mark Hart of U.S.-based Corriente Advisors.

Media reacts furiously

China's state media have reacted furiously to a Soros suggestion that the economy is coming in for a hard landing and expectations that the yuan will fall under speculative attack.

"Some people believe that the Chinese capital market is experiencing a major crisis, of which they try to take advantage with speculative actions and even vicious shorting activities," Xinhua said on Jan. 23.

In a commentary, Xinhua warned that "reckless speculation and vicious shorting will face higher trading costs and possibly severe legal consequences."

In another commentary last week, Xinhua repeated the assurance on the currency's stability yet again after a front-page story in The Wall Street Journal on hedge funds betting against the yuan.

But international pressures may continue to grow following estimates that China's capital outflows reached U.S. $1 trillion (6.5 trillion yuan) last year, Bloomberg News said, noting that PBOC reserves fell U.S. $513 billion (3.3 trillion yuan) in their first annual loss since 1992.

In a sign of continuing pressure on the currency, the PBOC said Sunday that China's foreign exchange reserves were down by nearly U.S. $99.5 billion (654.3 billion yuan) in January to U.S. $3.23 trillion (21.2 trillion yuan) after falling by a monthly record U.S. $107.9 billion (710.2 billion yuan) in December.

The main reason for the lack of confidence in both the stock market and the currency is suspicion that China's gross domestic product growth is far lower than the 6.9-percent rate announced by the National Bureau of Statistics (NBS) for last year.

Although the official GDP growth figure was the smallest in 25 years, critics have cited "surrogate" measures such as power consumption and rail freight as indicators of a steeper slowdown.

While power use rose a scant 0.5 percent last year, according to the National Energy Administration (NEA), rail tonnage suffered a deep 11.9-percent decline after falling 3.9 percent in 2014, the National Development and Reform Commission (NDRC) said.

Adding to skepticism about the official figures, China's anti-corruption Central Commission for Discipline Inspection announced on Jan. 26 that it had placed NBS director Wang Baoan under investigation for "severe disciplinary violation" on Jan. 26.

The probe was disclosed only eight months after Wang, a former vice minister of finance, took the NBS post and one week after the GDP figures were announced.

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