China: PBOC acts further to protect the yuan; reserves record historical drop in August
September 15, 2015
The People’s Bank of China (PBOC) has taken bold steps to prevent a further depreciation of the yuan after having unexpectedly devalued the currency on 11 August. In the weeks following the devaluation, the PBOC intervened in the FX market by selling foreign exchange reserves to shore up the yuan. While the PBOC does not disclose the amount of its intervention, August data show that total foreign exchange reserves fell by USD 93.9 billion—the largest decline on record—to USD 3.56 trillion. This represents USD 412 billion less than in the same month last year and the lowest level of reserves since August 2013. The Bank’s action adds further pressure to the country’s FX reserves, which have decreased since Q2 2014 due to strong capital outflows amid expectations of continued currency depreciation, slowing growth and, more recently, equity market volatility. Rather than speculative moves, analysts believe that capital outflows mainly reflect economic fundamental and structural factors. FocusEconomics panelists expect foreign exchange reserves to total USD 3.68 trillion by the end of this year, while they are expected to remain broadly stable at USD 3.66 trillion in 2016.
Many analysts have questioned whether the Central Bank’s intervention is sustainable. There is a consensus that China’s massive foreign-exchange reserves give authorities ample room to stabilize the CNY even if capital outflows remain at the current levels. Nevertheless, a large-scale intervention in the FX market will not only be enormously costly in the long-run, but it could also derail the government’s efforts to strengthen the case for the Chinese yuan to be included in the special drawing rights (SDR) basket. Against this backdrop and despite the PBOC having broad toolkit, analysts reckon that the Central Bank will step down its intervention in the mid-term, thereby allowing the yuan to depreciate. FocusEconomics Consensus Forecast panelists expect the Chinese yuan to trade at 6.53 per USD by the end of this year. For 2016, the panel projects that the CNY will trade at 6.65 per USD.
In recent days, Chinese authorities unveiled new regulations and guidelines to fuel economic growth, as the latest indicators signal that the economy remains weak. Early in September, the State Council unveiled a new framework of the state-owned enterprise (SOE) system. The document enshrines market-based principles, improves corporate governance and encourages the SOE to diversify its ownership. While it could be a game changer for the economy and a catalyst for rebalancing China’s growth model, authorities will implement this reform only gradually as they did with previous initiatives. The Ministry of Finance (MOF) took action on 8 September that would have a more immediate impact, announcing that the government would strengthen its fiscal policy. Despite the lack of details, the MOF vowed in the statement to boost infrastructure expenditure, speed up execution of such projects, reform taxes and foster public-private partnerships (PPP).
With a more proactive fiscal and monetary policy stance, China has maneuvering room to successfully weather recent headwinds. Authorities, however, will have to deal with the dilemma of trying to simultaneously prop up growth and continue with the transition of the current economic model based on exports, debt and investment to one driven by consumption and services.