Evidence shows that the People’s Bank of China (PBoC) intervened to push down the renminbi (RMB) exchange rate before its band-widening move in mid-March, as seen in the sharp rise in its foreign asset accumulation without sterilisation.
Some observers have since jumped to the conclusion that the PBoC had changed its foreign exchange policy to devalue the RMB as a way to boost growth. The United States was quick to issue a warning against Beijing’s currency manipulation.
There is something wrong with this view. Devaluing the RMB is not in China’s best interest; Beijing would not make such a glaring error.
To start with, the RMB has risen by more than 30 percent against the US dollar and 40 percent in real effective exchange rate terms since 2005. Meanwhile, Chinese wages have soared while productivity growth has slowed. A small devaluation will not make any difference to China’s export competitiveness under such circumstances, and a large devaluation would not be tolerated by the international community.
Crucially, our research shows that net exports (a component in GDP calculation) have not contributed to China’s GDP growth since 2009. Any devaluation benefits would thus be small. In fact, net exports have been a drag on growth. This means that China’s economy has already moved from export-led growth to domestic-led growth. Structural reforms are meant to improve resource allocation within the domestic sector so that it can transit from being investment-led to being consumption-led.
Since there is still underlying upward pressure on the RMB (due to China’s external surplus), forcing it down by brute force via currency intervention would inflict heavy costs that would likely outweigh the benefits of devaluation. The most notable costs would include imported inflation (unwelcome just when the Chinese economy is slowing down structurally) and, crucially, a conflict with Beijing’s reform policy.
To force devaluation in the face of a balance of payments surplus, Beijing needs to flood the market with a significant amount of RMB so that supply becomes bigger than demand. But this liquidity spill-over from currency intervention would create excess liquidity in the domestic system and clash with the PBoC’s efforts to keep monetary policy tight to force structural reform and deleveraging.
Some also argue that China needs a weak currency to combat the deflationary forces that have been plaguing the Chinese economy in recent years. This is not true. China has experienced periodic deflation since the early 2000s, but the RMB has kept appreciating while economic growth has kept humming along. The exchange rate is not necessarily a tool for combating deflationary pressure in China’s case.
The point is that China has chosen to engineer a growth slowdown to force through some structural reforms. It has other policy options to boost growth, and RMB devaluation is not key among these because of the greater domestic bias in the new Chinese economy.
However, the exchange rate can be an auxiliary tool to strike a balance between growth and structural reforms. This is because under a balance of payments surplus, a temporary RMB devaluation would boost growth in the near-term via the liquidity spill-over from the foreign exchange intervention to the domestic system but not so much through the devaluation effect on exports.
Beijing’s prime goal is to push through economic restructuring, but it needs a temporary boost in economic growth to facilitate the process. The RMB exchange rate plays this facilitation role. There may be more controlled weakness in the RMB in the near-term, but Beijing has not shifted its policy towards devaluation. The RMB should still experience mild appreciation pressure in the medium-term, albeit with relatively higher volatility than in the past.
The writer is a senior economist of BNPP IP (Asia) Ltd.
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