In Conversation with AGI's Experts: On the RMB Devaluation

MICHAEL SPENCE
ADVISORY BOARD CO-CHAIR

China has made great strides in letting “market forces take over.” Has this controlled devaluation signalled the end of an effort which was announced during the Third Plenum?

No, I don’t think so. It probably mainly signals weakness in overall growth, not just in the export sector. It means that the domestic growth engines in the domestic economy (on the supply and demand side) may not be working as well as the policy makers had hoped. The stock market volatility of late did not help in this respect. It is useful to remember also that while the RMB has had a small devalution with respect to the U.S. dollar it has had, over a year or so, a large appreciation relative to the Euro and the Yen.

China’s growth has been lagging (by its own standards) for some time now. Do you see this devaluation as part of the government’s need to stablilize the economy and is this a sign that China could be prepared to see reform take a back seat to stability?

In the sense and in part, it (the move) is designed to limit declines in export growth. But I don’t see this as taking a back seat to reform, or to the structural transformation of the economy. It is more like fine tuning the path. They (the Chinese government) do not want to see growth fall significantly below 7 per cent this year and next. It is clear that growth is a challenge and this is part of the response. I would expect other measures also focused on domestic consumption and investment.

How might this move affect efforts to internationalize the RMB? The IMF has already said that China has some way to go in letting the currency float freely.

This will not help, but it may not be fatal. PBOC (the People’s Bank of China) reserves have been declining, which suggests that markets may be signalling that the RMB needs to decline relative to at least some other currencies. So you could interpret the recent moves as reflecting market forces. The PBOC just got out of the way.

Do you see this move as a spillover following the market volatility we saw in recent weeks?

Maybe in part. As I said in my recent piece on stock markets, Letting China’s Bubble Burst, there were regulatory mistakes made. Stocks are not yet a large enough fraction of household wealth for the stock market decline to derail the economy. But it did not shake confidence and was not a positive.

ANDREW SHENG
DISTINGUISHED FELLOW

The devaluation is sparking media speculation over fears of a currency war. Are these concerns baseless or is there merit?  

Talk of a currency war is over-the-top hype. The RMB has moved less than 2 per cent, whereas the Yen, Euro and Australian dollar have moved double-digits against the dollar.

Do you see this move as a competitive devaluation, as some investment banks have described it?

This is not a competitive devaluation. There are two good reasons why the RMB should be more flexible. First, being very stable to the dollar means that monetary policy becomes “tied” to U.S. monetary policy. A more flexible exchange rate allows more room for monetary policy action to take interest rate adjustments very different from US rates. This is exactly what the ECB and Bank of Japan claim, that their currency moves are the result of their monetary policy. Secondly, there has been debate recently whether China is beginning to see some capital outflow, with a slight decline in the FX reserves. Some of that decline may be due to valuation considerations, but capital outflows larger than the trade surplus must mean that exchange rates will have to reflect the market trend.

The move is well within the band of 3 per cent that the PBOC announced earlier, so the market should not have been that surprised. I think the market was too used to the micro-movements in the RMB that were easily predictable. The whole world wants flexible exchange rates, except not too volatile.  A 1.9 per cent move cannot be considered volatile, especially if other major currencies have moved far more.

Would you say that the yuan’s devaluation can be linked to the need for stabilizing the economy? Would this then mean that China is prepared to see reform take a back seat in the interest of economic stability?  

I personally do not read this recent move as negative to reform efforts. If anything, the move represents a distinct effort to make the exchange rate and later the interest rate more market determined. All these measures reinforce the need to proceed with reform efforts. Instead of being in the back seat, the reform agenda is foremost in Beijing’s mind. How to proceed and the sequencing of the next step of reform are the key questions.

My observation is that the RMB move and the consideration whether it could join the SDR basket are related. First, the move is in sync with the IMF condition that the RMB should be more market-determined. Second, the RMB policy has been extremely responsible towards global financial stability, because the RMB has remained very stable with the US dollar and has borne its fair share of global adjustments. If the international community does not feel that RMB is contributing and should not join the SDR basket for geopolitical reasons, then the Chinese authorities may have to re-consider whether its present policies are contributing to global and China’s own interests.

This is a signal that the major shareholders of the IMF should not take China, nor any other members, for granted.

XIAO GENG
HKU PROFESSOR

The PBOC’s move to use the RMB’s last day market closing exchange rate to settle the opening day’s mid-price is clearly one step forward toward a market-oriented yuan. It also demonstrates that, when necessary, the PBOC has enough fire power to stabilize the RMB exchange rate at the level that is consistent with medium- and long-term market conditions. If the market expectation of what the RMB exchange rates don’t reflect economic conditions in the medium- and long-term, the PBOC can still use the daily limit of 2 per cent, or engage in the direct buying or selling of its holdings of foreign exchange reserves. These reservers are still at about 3.65 trillion U.S. dollars, even if they are lower than the peak of 3.99 trillion U.S. dollars from about a year ago.

The fact that the PBOC allowed for the depreciation of the RMB reflects its shift to a more relaxed monetary policy. This change will support the real economy, and can also support the various fiscal measures aimed at generating new, smart and quality investment in urban public infrastructure. It may even fix problems arising from debts incurred by non-performing infrastructure built during the boom cycle of 2008-2012.

As more aggressive monetary, fiscal, and reform policies are initiated and implemented, the Chinese business cycle could touch bottom, but reform dividends are also expected to appear gradually over medium and long term, and these are crucial for maintaining RMB’s competitiveness.