jueves, 27 de agosto de 2015

jueves, agosto 27, 2015

China’s Weak Yuan Temptation Could Prove Irresistible

By Shen Hong  

Next time China makes a major easing move, it can defend the yuan or let it slide slightly. Next time China makes a major easing move, it can defend the yuan or let it slide slightly. Photo: European Pressphoto Agency


It took just three days for Beijing to stabilize the yuan after it unleashed a surprise regime change in currency policy. The current peace might provide a false sense of security, especially if more monetary easing is in store.

After the People’s Bank of China jumped into currency markets to put a floor on the plunging yuan, officials promised stability going forward. In theory, China could stick to its guns and prevent more depreciation. But now that it has cracked the door open on its exchange-rate policy, the more Beijing conducts monetary easing, the more temptation it will have to let the yuan depreciate in tandem.

Under China’s de facto fixed exchange rate system, when capital flowed out, the central bank defended the exchange rate by buying yuan with foreign reserves. But when the central bank buys yuan, it is essentially shrinking the money supply, which is hardly what policy makers want in a slowing economy. By letting the outflows happen without intervening in the currency, the central bank can keep domestic money supply flush.

 

This matters because outflows have been persistent—and could pick up as interest rates fall further.

By one measure, the central bank and financial institutions sold nearly 250 billion yuan of foreign currencies in July, during the worst of the stock-market meltdown. Some of that outflow may be virtuous outbound investment and tourism spending, not necessarily pernicious capital flight, but it makes the central bank’s job difficult all the same.

To counteract the outflows, the PBOC this week provided banks 240 billion yuan ($37.5 billion) in short-term lending. If outflows continue—and the economy fails to respond to the cuts already in the system—more durable easing measures such as a cut to bank reserve-requirement ratios seem likely.

Next time it makes such a big easing move, however, China now faces a decision that it chose not to consider in the past. It can defend the currency by spending reserves to buy yuan to keep it stable. Or it can let the currency slide a bit. The latter choice has the potential to make the easing more effective.

Beijing likely remains squeamish when it comes to letting the currency fall too much and too quickly, so it won’t give up on currency intervention completely. A sharp fall in the yuan could make the capital outflow problem worse.

But at the next round of easing, China’s instinct may be to use its new flexibility on the currency to make the easing moves work better. That means that the current currency quiet is only temporary. Investors should be prepared.

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