Transparency is one of the cornerstones of a modern central banking system. It alleviates worries, clarifies uncertainties and promotes confidence in the market and the general economy. But central bankers in China frequently have a hard time understanding the necessity of it.
On the night of November 29th, the State Administration of Foreign Exchange (SAFE), a secondary bureau within China’s central bank – the People’s Bank of China (PBoC) – issued a terse statement saying that it would crack down on fake transactions while continuing to clear genuine ones.
Apart from fathoming the criteria winnowing the ‘genuine’ from the ‘fake’, market observers are also speculating the next move of the PBoC, when the dollar appreciation has already pushed the renminbi to a record low in almost eight years. PBoC’s whopping FX reserves, most of which are held in the form of US Treasury bonds, are also declining for the third consecutive quarter and reached a record four-year low.
The renminbi and the PBoC’s monetary policy are facing fresh challenges from worldwide governments and investors. But given PBoC’s abundant armouries and the central government’s traditional commitment to robust economy growth, the renminbi’s earthward curling may end sooner than expected.
The PBoC’s foreign reserves are the biggest in terms of dollar values. The amount of $3,000bn or so dwarfs Japan’s $1,260bn, the UK’s $145bn and the US’s $120bn. The central bank has enough ammunition to fire in case of emergency in order to hold up the renminbi’s value and prevent strong capital outflows that may generate liquidity or worse, solvency problems in domestic markets. With the dollar value continuing to rise, so does the value of the PBoC’s foreign reserves. Dumping dollars in the open market to maintain the value of the renminbi is not a costly choice for the PBoC.
China’s Communist Party has a long history of galvanising economic growth to maintain political control of the country, and therefore will by no means withstand any action that runs counter to the economy growth. Even though a sliding renminbi contributes to the comparative advantage of Chinese products in the global markets by making them cheaper, a free fall of the currency can also explode the already colossal money supply and blow up dollar-denominated loans owed by Chinese SOE companies, many of whom have a poor record of making intelligent foreign investment decisions.
The October, the renminbi was officially included in the IMF’s special drawing rights (SDR), a unit of account defined by the IMF and whose value is based upon a basket of key international currencies. The currency selection has several integral and equally crucial criteria, one of which is the freely usable criterion. Under the criterion, a currency must be widely used. A broad range of indicators can reflect the degree of renminbi’s popularity: foreign governments’ official FX reserves, renminbi-denominated international debt securities (IDS) outstanding and cross-border payments.
A volatile renminbi is not a welcoming sign for those central banks who want to include it in their foreign reserves. The currency’s volatility may transmit into central banks’ official reserves’ volatility or worse, the general economy, should the renminbi constitute a large slab of a central bank’s foreign reserves.
A free falling renminbi also makes borrowers of renminbi-denominated IDS worse off since the face value of their liabilities skyrockets. Businessmen may hesitate to use renminbi as cross-border payments in international trading as well, fearing that the currency’s uncertainty may expose them to undue FX risks.
All three scenarios hurt the renminbi’s reputation as a global currency and China’s long-term ambition to transform it into the world reserve currency. Therefore, the PBoC is unlikely to stand by and watch the renminbi go wild.
During his campaign, US President-Elect Donald Trump frequently neglected the IMF’s clarification and kept accusing China of manipulating its currency in order to gain unfair advantages in international trading, and thus compromising American products. However, Trump’s claim is at least untrue during the post-election period, when the PBoC has been endeavouring to prevent renminbi from free falling by consuming large chunks of its foreign reserves to maintain the currency’s value.
That being said, Trump will likely still try hard to press the PBoC to appreciate the renminbi in order to demonstrate that he is a man who keeps his own words and protects those blue collars who put him at the helm of the country. The PBoC should hence be discouraged from devaluing the renminbi. Since a sanguine relationship between the two biggest economies in the world will significantly decide China’s future, to meddle with this relationship by depreciating the renminbi and giving Trump an excuse would only be the worst start.
Consequently, though multiple headwinds exist for the renminbi appreciation, the market should not expect it to plummet to the level a decade ago when the PBoC introduced its most recent exchange rate reform. A rate of 7 for the renminbi/dollar is a reasonable guess.