Are currency movements and capital outflows the relevant lever for China problems?

by on June 17, 2014 at 1:25 am in Current Affairs, Economics | Permalink

Maybe so:

There are some benefits to a weaker currency, such as more competitive exports. But with China’s current account surplus having shrunk from 10 per cent of gross domestic product in 2007 to just 2 per cent now, net outflows have a bigger impact on currency markets.

“[Policy makers] need the renminbi to go down, but that then unlocks Pandora’s box,” says Ms Choyleva. “If you exclude the exchange rate gains there’s nothing much left to invest in China.”

Kevin Lai, head of Asian economic research at Daiwa, believes the moves to guide the renminbi higher last week by the People’s Bank of China are a sign that authorities are “deeply concerned” the recent trickle of capital outflow could become a damaging flood – especially if the US Federal Reserve’s unwinding of asset purchases entices capital out of emerging markets including China.

The PBoC has for years expanded its balance sheet as foreign capital flowed in, he explains. Now, with capital beginning to flow out China’s central bank is being forced to add cash to the economy without the underpinning of US dollar inflows. That, in turn, is contributing to renminbi weakness.

His forecast is for a further 8 per cent fall in the Chinese currency against the dollar by the end of 2015, to Rmb6.83 from Rmb6.21 now, pushing back down through the 18-month lows plumbed in recent weeks.

“If the renminbi keeps going down, the market will demand a real answer and start pulling money out. That is the worst fear of the PBoC,” says Mr Lai.

That is Josh Noble from the FT, there is more here.

1 [insert here] delenda est June 17, 2014 at 2:13 am

I want Scott Sumner’s take on this.

2 8 June 17, 2014 at 3:07 am

Every time the reserves stop accumulating, the yuan has slumped. China can control the onshore RMB price, but not the offshore price in HK without spending currency to do it. As soon as reserves stop accumulating, Chinese exporters don’t bring dollars back and to the extent that they can, Chinese sell RMB and buy dollars. (They might also buy gold if the CNY/gold price increases, since gold is easier to buy than USD.)

The drop in the yuan is not so much a policy solution as the free market solution. Money and credit were created at an incredible pace and much of the investment behind that credit is malinvestment. The decline in the currency is the market correcting the imbalance. To not weaken the currency will invite deflation, or conversely, should they try to print their out, an even bigger devaluation down the road either via currency depreciation or high inflation.

3 JWatts June 17, 2014 at 10:44 am

“much of the investment behind that credit is malinvestment.”

Indeed. One small area that I’ve looked at is the build out of wind turbines in China. The core numbers are hard to hide and perhaps it’s indicative of other areas.

China has the largest wind power production capacity of any country, 91.4 GW.
The US, for comparison, has a production capacity of 61.0 GW.

Theoretically, China should be producing a lot of power. But the actual power produced (assuming the underlying statistics are true) is 118 TWh versus the US producing 141 TWh.

It seems unlikely that China is deliberately under reporting power production by sector, so this seems like a sure indicator of billions of dollars of sub-optimal investment. It would seem surprising if this is distinct to just this one type of investment. It seems more likely that the Chinese are very good at building out vast quantities of industrial goods, but pretty poor at allocating the output efficiently.

4 Zachary Iqbal Latif June 17, 2014 at 4:21 am

I think all emerging markets are going to be hit by the tightening trend that’s especially developed in the Anglo-Saxon economies (Oz, UK & US).

After all cable at 1.70 is at multi-year highs and currency strength is going to favor GBP & USD especially as there is pressure on higher yields (and restructuring of shorter term interest rates) in US treasuries.

The asynchronous nature of the economy where the flow of capital is beginning to redirect away from emerging markets (and even Japan, the EU & Switzerland) back to the days of the infamous carry trade is invariably going to hurt growing (but inefficient) markets like India, China & Africa.

Risk-return metrics are the basis for good investment and why accept moderately higher yields at substantially higher risk levels.

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