“Most importantly, in terms of PBOC leadership an PBOC direction in policy, this is a huge backpedaling”.
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But taking on this role needs to be supported by economic fundamentals – does China merit this coveted status from an economic standpoint?
The People’s Bank of China (PBOC) conducted a net injection of 60 billion yuan into the banking system last week.
This was followed by further rounds of devaluation the next two days.
China devalued its currency on 11 August 2015 and this sent tremors across the financial markets globally.
There is little argument against the fact that China’s conventional investment-export economic model seems to have run out of steam and growth has entered shaky terrain.
Forex reserves are a basic tool used by countries to control the value of their currencies. “The current devaluation, in case of Chinese yuan, is only a structural adjustment which was overdue”, he says.
Barron’s relates China’s move to President Richard Nixon’s Aug. 15, 1971 “temporarily” abandoning what was left of the gold standard (Barron’s Aug. 17).
That widened spread is complicating China’s ambitions to raise the yuan’s global profile.
“Their overall growth rate is slowing faster than they want”, said Dave Denoon, director of the Center on U.S.-China Relations at New York University. And, as noted, its currency has fallen much further than China’s. “Where we go from here is an open question, but what’s clear from the above is that between China’s FX reserve drawdowns in defense of the yuan and the dramatic decrease in petrodollar flow, the self-feeding loop that’s sustained the dollar and propped up USD assets is now definitively broken and we are only beginning to understand the consequences”.
China officially maintains a largely closed capital account, meaning it restricts the ability of individuals and businesses to move money across its borders. There are no such requirements for reserves in China’s local currency markets. However, officials argue that the real intention was to set exchange rates in accordance with market practices. If ordinary investors decide the yuan will not protect their savings, they can buy gold, property, Bitcoin and overseas assets, including within China via an ETF tracking a foreign market. The new uncertainty is posing a major challenge to Asian economies.
There was always a risk, however, that Beijing would eventually decide that instead of running down foreign currency reserves to support the yuan, it would be easier to severely restrict capital outflows. This will hurt the economy even more, compelling the government to intervene – the very concept the potential reserve currency holder is trying to move away from. But China’s latest move creates another currency against which the dollar can appreciate. This implies that allowing the exchange rate to float would lead to further devaluation. Financial reforms are opening up the world to smaller and less internationally savvy investors, and the recent dip in the yuan has spurred them to take advantage of new opportunities. Foreign investors sold a record amount of Indian shares in August, offloading even more than in the midst of the global financial crisis. The yuan’s depreciation reduces China’s spending power, and unsurprisingly emerging market currencies have continued to decline.
According to Reuters, 85 per cent of trade in the equity market is retail.
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This came despite the efforts of the China Securities Finance Corporation (CSFC), the state-owned company that provides finance to brokerages, doing its best to prop-up the stock market with the $433 billion at its disposal.
