18 January 2019
China is unlikely to abandon its defensive stance on the renminbi even as the nation pursues monetary easing. Photo: Bloomberg
China is unlikely to abandon its defensive stance on the renminbi even as the nation pursues monetary easing. Photo: Bloomberg

More China easing likely, but don’t expect RMB to roll over

A gauge of mainland liquidity has been in a continuous slide since February 5, pointing to tight conditions in the money market there.

Given this situation, the People’s Bank of China (PBoC) is likely to pump more money into the system soon, assuming that there are no unforeseen political events. The central bank may prefer large-scale monetary easing measures such as reserve requirement ratio (RRR) cut.

The last RRR cut took place just three weeks ago. Now, it is worth bearing in mind that in late 2008 the PBoC launched two RRR cuts within a span of three weeks.

How will the stock market react to the likely easing? Looking back, mainland equities responded to the last RRR cut earlier this month very positively, at a time when Hong Kong and other overseas bourses were relatively calm. In fact, Hong Kong’s benchmark Hang Seng Index even showed a negative reaction to China’s easing move.

The market reactions are understandable, since monetary easing also sends a signal that economic growth remains subdued. 

Also, the additional liquidity released by the RRR cut amounts to some 600 billion yuan, which lags far behind the 60 billion euro monthly bond purchase of the European Central Bank and Japan’s 80 trillion yen of monthly Quantitative and Qualitative Easing (QQE).

Against this backdrop, China’s upcoming easing has to surprise the market in terms of either the size or coverage. If that doesn’t happen, there might be a significant risk for investors who rush into the market earlier in a speculative frenzy.

The renminbi, meanwhile, has been under substantial depreciation pressure in recent months. The onshore renminbi exchange rate continues to move close to the lower end of the daily trading band of 2 percent of the official central parity rate.

In fact, the Chinese currency has fallen a further 0.8 percent so far this year on top of a 2.4 percent drop in 2014. And the latest figure of funds outstanding for foreign exchange points to short-term pressure of capital outflow. Some observers feel China may adopt for further renminbi depreciation to combat the ongoing global currency war.

Well, are the fears well-founded? I personally think that there is limited chance and scope for sharp renminbi depreciation.

Beijing has accorded top priority to internationalizing its currency. And the PBoC has signed currency swap deals with nearly 30 countries during last six years. That has made the renminbi more frequently used in global trade settlement. And the Chinese central bank has also made many arrangements in setting up offshore renminbi centers in various nations and regions.

Also, currency depreciation may offer very limited help. Weaker renminbi may help boost China’s exports and overall economic growth. However, it remains questionable as to how much benefit exporters will really get given that most developed economies, barring the US, are still struggling.

Meanwhile, sharp renminbi depreciation may not only hamper China’s economic restructuring but will also accelerate the capital outflow and trigger a vicious currency deprecation war. What’s even worse, that would exacerbate the global deflation pressure, which may put world economy under more pain.

Moreover, weaker renminbi may increase the debt burden for Chinese companies. The outstanding debt of Chinese companies totals some US$1.1 trillion, of which a substantial portion is denominated in US dollars.

Mainland Chinese companies have been rushing to borrow US dollar debt in recent years. Dollar debt accounted for up to three fourths of their incremental borrowings throughout last year. Therefore, sharp fall in renminbi exchange rate may inflate their debt and squeeze profits.

Overall, the renminbi has held up well against a basket of currencies despite moderate slide in the onshore exchange rate. The trade-weighted index of the Chinese currency has risen by 6.4 percent last year, which points to the nation’s increasing trade value with commercial partners.

The PBoC is unlikely to abandon its defensive stance on exchange rate. So, a sharp weakness in the renminbi may not be in sight in the short term.

This article appeared in the Hong Kong Economic Journal on Feb. 26.

Translation by Julie Zhu

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Hong Kong Economic Journal chief economist and strategist

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