The People’s Bank of China (PBoC) is busy fighting for pricing power over the renminbi exchange rate.
But pushing up Hong Kong interbank rates and draining the offshore renminbi pool is a double-edged sword.
The surprise move by the PBoC shocked speculators.
Michael Every, chief of financial market research of Rabobank, called it “murderous”.
In a commentary on Wednesday, China’s Economic Information Daily said it’s a bad idea to let the offshore market dictate the renminbi exchange rate.
It said the more the PBoC uses its foreign exchange reserves to stabilize the renminbi, the more it will stoke expectations of devaluation because of concerns the strategy is not sustainable.
The PBoC decision may help boost the renminbi exchange rate briefly and dampen such expectations.
The move has short-term advantages including easing capital outflow and allowing some breathing room for the commodities and currency markets.
Hongkongers who hold renminbi assets can also take a deep breath.
A rebound in the Hang Seng Index is partly due to recovering sentiment in the renminbi foreign exchange market.
But there are also several negative effects, not least is the potential harm to renminbi internationalization and to China’s efforts to win pricing power in global commodities.
The purpose of being in the International Monetary Fund’s SDR (special drawing rights) basket is to make the renminbi grow as a global currency.
But the PBoC’s attempts to stabilize the renminbi exchange rate by draining the offshore renminbi pool is doing just the opposite.
In November last year, before the IMF approved the renminbi’s SDR inclusion, the market had hoped to see a market-oriented exchange rate.
But overseas investors were scared to invest in renminbi-denominated assets.
In fact, after the so-called “national team” started to intervene in the A-share market to stem a massive sell-off, market valuations became distorted.
The Hang Seng A-H premium index closed at 139 points on Wednesday.
That means A shares are four times more expensive than H shares.
With mainland investors grappling with low confidence in the mainland stock market and foreign players reluctant to invest, there’s no motivation for new capital to enter the market.
The Shanghai Composite Index slipped below 3,000 points for the first time in a year. It may be just the beginning of a bear market.
Lastly, if China insists on keeping the renminbi exchange rate at a level the market perceives as “too high”, it will limit its own ability to cut interest rates and banks’ reserve requirement ratio.
To maintain a stable renminbi exchange rate, China cannot cut interest rates too much.
Otherwise, it will put more downward pressure on the renminbi as the interest spread between the renminbi and the US dollar narrows.
That, in turn, will reduce the effectiveness of any rate cuts in boosting the domestic economy.
Companies facing bankruptcy will increase, along with default risks.
The PBoC should be very careful in how it wields this double-edged sword.
It’s a test for policymakers as they try to balance the need to increase the renminbi’s pricing power with the goals of the currency’s internationalization and that of the domestic economy.
This article appeared in the Hong Kong Economic Journal on Jan. 14.
Translation by Myssie You
[Chinese version 中文版]
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