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| People's Bank of China, Photo Courtesy: Wikipedia |
From Deng era onward
China enjoyed high growth rates. Many predicted an end of that phenomenon for
long. However, China didn't fit into their equations. Now it looks like the
economy is finally slowing down. Its fine, after all no country can clock a growth
rate of above 7% infinitely. For 25 years ended in 2015 China's growth rate was
7% or above. As the economy becomes bigger, maintaining high growth rates year
after year is a challenge for any country.
Current concern has
more to do with rapidly depleting forex reserves, real estate bubble and huge
unrecoverable debts in Chinese bank's balance sheets. In addition to that, most
of provincial government's budget doesn't looks good.
For a long time
China allegedly manipulated the currency to make her export highly competitive.
However, now she is struggling to keep her currency depreciations within range.
Market interventions for this already proved very costly to China's forex reserves.
China could have let her currency gain value in boom years when huge amount of
money (dollar, euro, yen) in the form of payment for manufacturing goods and
capital investments flowed in to the country. But they didn’t do that. Instead
government bought all those and built a mammoth trophy for the world to see -
close to $4tn forex reserve. Was such a big forex reserve was required? Well,
it's another question for another day.
In last December
Chinese reserves fell by $108bn; in January the number was $99.5bn. From
mid-2014 reserves fell from a magic number of $4tn to $3.23tn. As a matter of
fact, IMF model suggests that an "economy of China’s size needs $1.5
trillion with strict capital controls and $2.7 trillion without them".
That means China is very well safe. The questions are, will China stop
intervening in market and let the yuan fall? How far they will take the money
out of reserves to keep Yuan stable? Will China impose capital controls?
As per Bloomberg
report, "Capital outflows increased to $158.7 billion in December, the
most since September and were $1 trillion last year, according to estimates
from Bloomberg Intelligence. That’s more than seven times the amount of cash
that left in 2014".
By the way China
still have the biggest currency reserves in the world.
Chinese are not
sitting idle. In addition to the use of reserves, As per NYT reports,
"They also made it harder for Chinese citizens to use their renminbi to
buy insurance policies in dollars… Beijing bank regulators have halted sales
within China of investment funds known as wealth management products that are
denominated in dollars… also instructed bank branches in Hong Kong to limit
their lending of renminbi to make it harder for traders and investors to place
bets against the Chinese currency in financial markets".
Chinese leadership
may be in a fix now. They can't let the currency depreciate too much, as it
will it will accelerate the demand for dollar and downward journey of yuan. At
the same time, they can't tap in to forex reserves too much because Chinese
leadership were using huge forex reserves as a trophy of their success. Hence,
it may not look good on current leadership if the reserves contracted too much.
Imposing strict capital controls may reduce the amount of dollar inflow as
foreign fund managers may not be so interested in an economy from which they
can't pull back the money. In addition to that Chinese funds and companies may
also try to take money out of China, if strict capital controls were imposed.
Well, one immediate
causality may be the reduction on China's huge investments in non-critical
infrastructure projects. They may not construct so many costly highways which
have more to do with building an impressive image abroad than economic
viability. Will the highway planned to pass through highly contested Pak
Occupied Kashmir and finally to reach sea (after passing through highly
terrorist active areas) be in the causality list? Let's wait and watch.
Sajeev
References
1. New York Times
2. Bloomberg
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