Should China consider renminbi revaluation?
The causes behind the current meltdown in global equities, commodity prices and EM currencies are complex, inter-connected and at times self-reinforcing. But at the heart of the problem lies the inability of policy-makers from Washington to Beijing to engineer a more robust path for economic growth in which the private sector can believe in. This problem, which is largely structural in my view, has been compounded by cyclical challenges including stretched positioning in riskier assets and historically weak equities in August, as well as country-specific concerns in Malaysia, Brazil and Russia to name but three.
In China, the two historical engines of growth – fixed investment and exports – are spluttering. Large scale fixed investment in infrastructure and property, fuelled by aggressive credit growth, has led to ever-diminishing returns and is now causing the private sector and banks much pain. Unfortunately for China, weak global demand has in tandem depressed Chinese exports (see Figure 1). Chinese investors have subsequently been looking for an alternative source of return on investment and turned to equities, fuelling the euphoric performance of Chinese stocks until mid-June.
I don’t think the global situation today is as acute as in 2008 as the banking sector in particular more robust. Furthermore, data do not support the view that Asia is on the verge of another 1997-type crisis. I will explore this topic in my next research note but I would point out for now that, despite the much-talked about rise in EM external debt, Asia’s short-term external debt has been broadly stable as a percentage of both GDP and central bank FX reserves (see Figure 2).
Policy-makers in developed economies running out of policy tools
At the same time, the set of policy-tools available to central banks and governments is more limited than it was seven years ago. Policy rates are already at or near record lows in developed economies and Europe, and in some cases in negative territory, and large-scale quantitative easing has been deployed with at best mixed results. Central banks which pulled the QE trigger early and in size, the US Fed and Bank of England, have seemingly reaped greater rewards than those which waited, namely the European Central Bank (ECB), or didn’t go big soon enough such as the Bank of Japan (BoJ) – see European Central Bank QE: A little late to the party, 8 January 2015.
While the ECB’s QE has arguably contributed to circumventing market contagion from the Greece debacle and to boosting the euro’s competitiveness, eurozone GDP growth has picked up slowly (to 0.3% qoq in Q2) and from a low base. There is little evidence that large scale bond purchases have done much to spur bank lending, corporate investment and household spending and ultimately employment and growth in large economies such as France and Italy. A stronger euro and the recent equity market meltdown, which has whipped trillions off company valuations and portfolio holdings, is unlikely to do much good to any nascent recovery in investment and spending.
Emerging markets’ policy dilemma
Some emerging market central banks may well have room to cut policy rates, in the face of weak commodity prices and subdued inflation, in a bid to support growth. China took the lead today by cutting is lending rate 25bp to 4.6%.
As I argued in Asymmetric Risk to Emerging Market Monetary Policy (6 August 2015), EM real policy rates remain quite high by historical standards. Figure 3 shows that in the Philippines and South Africa, policy rates have actually risen in the past twelve months despite substantial falls in headline CPI-inflation, while central banks in India and Thailand have cut policy rates far more slowly than the fall in inflation. In Mexico and Taiwan, the policy rate has remained unchanged despite CPI-inflation falling 1.3 percentage points and 2.4pp, respectively.
The argument against rate cuts is that they could accelerate FX outflows from these economies and further weaken already vulnerable currencies, even if a Fed rate hike at the 17th September meeting is off the cards. EM central banks could of course continue to draw on still vast FX reserves to slow or even reverse the pace of currency weakening but history suggests this is a measure of last resort with a limited shelf-life. This dilemma would be largely resolved if the CNY was appreciating, as I argue below.
CNY devaluation has done more harm than good
The much-touted currency wars are wars only in name and largely futile. In particular, the Chinese central bank’s recent surprise decision to devalue its currency by about 3% versus the US dollar has seemingly done more harm than good on the global stage.
For starters, it has drawn further attention to the Chinese authorities’ somewhat desperate bid to support exports and growth and if anything exacerbated concerns that actual GDP growth is quite a bit slower than the official 7% reported. Furthermore, it has exacerbated FX outflows from other Asian economies and currency depreciation, putting further pressure on wider emerging markets. With the majority of the currencies of China’s trading partners also weakening versus the US dollar, the renminbi’s overall competitiveness has improved only marginally (see Figure 4). Chinese exports are thus unlikely to see much of a boost, particularly given the sluggishness of global demand
The same story applies of course to the rest of Asia. Figure 5 shows that a GDP-weighted basket of Asian currencies (excluding China) has weakened versus the US dollar by about 12.5% and 7.5%, respectively, since August 2014 and early April 2015. However, the nominal effective exchange rate (NEER) of this basket – which best captures Asia’s overall currency competitiveness – has only weakened 2.7% in the past twelve months and 6.5% since the multi-year highs in mid-April. Admittedly, the recent appreciation of the currency of the eurozone – which absorbs 10-20% of Asian exports – has meant that the depreciation in Asian NEERs has tracked pretty closely the depreciation of Asian currencies versus the US dollar.
Renminbi revaluation would have multiple benefits
I would therefore argue that Chinese policy-makers should take a very different stance and consider revaluing the renminbi.
- It would not harm China’s chances of having the renminbi included in the IMF’s SDR basket (while keeping the US Treasury on side, which should not be underestimated).
- Near-term it may help alleviate concerns that Chinese economic growth is slowing sharply while helping to curb FX outflows from China and the pressure on the central bank’s FX reserves. It would
- It would reduce the local-currency cost of servicing China’s FX-denominated debt. While China’s total external debt stock officially remains modest at about $895bn or 9% of GDP, about 70% is made up of short-term debt (i.e. debt with an original maturity of less than a year), which is in turn mostly US dollar-denominated and thus vulnerable to US dollar appreciation and/or higher US rates.
- Perhaps more importantly, a renminbi revaluation would boost domestic demand and in turn support European and Asian exports and growth and ultimately global demand. Put differently, a stronger renminbi would help erode current imbalances – as depicted by the rise in China’s trade surplus to record levels in Figure 1.
- Of course, a stronger renminbi may lead to other Asian currencies also appreciating. But Asian central banks outside of China could cut still reasonably high policy rates and/or intervene in the FX market to slow the appreciation of their currencies and rebuild FX reserves. Rightly or wrongly this would help put a floor under markets unnerved by the fall in the US dollar value of EM central bank FX reserves (see Headline EM FX reserves distort the real story, 2 June 2015).
- One potential added benefit is that a stronger renminbi versus the dollar, if combined with a pick-up in developed economies’ exports, would make it easier for the Fed to justify the start of a slow and steady rate hiking cycle and finally pop the unnerving uncertainty about the timing of the first Fed rate hike.
A stronger renminbi would of course hurt low-value added exporters near-term but it would force exporters to go up the value-added chain, which ultimately is the government’s long-term ambition. This would in turn leave exporters in a better position to capitalise from a recovery in global demand.
The government has the resources to smooth this transition from an economy led by infrastructural investment and cheap exports to a higher-tech and consumer-led economy and reduce the associated social costs. This would arguably be a better use of resources than artificially propping the stock exchange, which the government has attempted to do without great success so far. After all this is a path well trodden by many other countries, such as the US in the 1960s and the UK and Singapore in the 1980s to name but a few.
To be clear, I think it’s unlikely that Chinese policy-makers will go down this path and in any case it would not benefit all of China’s trading partners’ equally. Years of over-investment in infrastructure and housing (the opposite problem to the US and UK) are likely to depress Chinese demand and imports of raw materials and commodities such as iron ore and coal, which will be detrimental to the likes of Australia. Conversely the transitions towards consumer consumption, with a focus on health and the environment, and continued growth of a middle class is likely to see greater demand for higher-end goods and services.
Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.