China: caught in the trap of cautious monetary reforms

Chinese renminbi

The International Monetary Fund (IMF) assures that China is in a transition process towards safer and higher quality growth. A transition it believes has “challenges and is necessary”.  So the monetary organisation publicly welcomes the Chinese Communist Party’s efforts and economic reform plans aimed at navigating the consequences of stagnant growth.

The IMF estimates China’s economy will grow this year by 6.8% (two points below the official prediction from China: 7%). According to the IMF,  this significant slowdown is a logical consequence of the country’s process of change. But beyond the flattery of the IMF’s latest report, China continues to struggle to avoid being swallowed up by the challenges which stifle its economy while developing a new monetary policy.

In mid-May, The People’s Bank of China (PBOC) announced an interest rate cut for the third time in six months. As a result, the one-year lending rate  limit will be reduced by 25 basis points to 5.1 percent. In tandem, the bank will also cut the benchmark deposit rate by 25 basis points to 2.25 percent. PBOC expects this measure to help alleviate the “big downward pressure” choking its economy and make Chinese exports more competitive. “At the same time, the overall level of domestic prices remains low, and actual interest rates are higher than the historical average,” said the PBOC in an official statement.

China announced plans for easing its monetary policy in January this year. It warned its actions would be “cautious”.  This is mainly due to the fact that while the second largest economy wants its currency to be able to compete internationally at the same level as the USD, the large amounts of accumulated debt are a concern in as far as they raise the eventual risks prompted with further liberalization.

But caution is complicating  a rise in domestic consumption and the RMB’s greater convertibility; both top priorities for Beijing. Analysts, for example, showed little optimism over the new interest rates cuts. They think the PBOC is reacting slowly and with little enthusiasm, limiting the real effectiveness of the continuous  rate cuts over the past few months. Furthermore, local governments and large state enterprises will be the main beneficiaries, while SMEs and citizens will be most likely excluded. Banks fear the risks created by unpaid loans; and regardless of the PBOC’s requirements,  it maintains high interest rates rates for the small lender.

There is a similar controversy with regard to greater appreciation of the RMB. The IMF welcomed the steps taken by Beijing in its upbeat statement. And, for the first time in 10 years, it no longer considers the RMB an undervalued currency.

The Chinese government is mainly interested in receiving the blessing of the IMF to become part of its Special Drawing Rights Basket, along with the yen, the dollar, euro and sterling. This would establish the RMB as an international currency, while decreasing the influence of the USD as a reserve currency. Such a strategic move would also help the recently launched Asian Infrastructure Bank, founded by China.

The IMF will not make a decision until October this year. In the meantime, it has encouraged Beijing to pursue more flexible exchange rates to make the RMB freely convertible.

The decision to include the RMB in such a basket is sensitive and has significant political and economic implications.  Equally important, the RMB is silently internationalizing, which can play in favour of China against lobbyists who want to protect United States interests and the hegemony of the USD. For instance, Deutsche Boerse AG recently announced the creation of the China Europe International Exchange. Based in Frankfurt, it is the product of a partnership between two Chinese stock markets, Shanghai Stock Exchange and China Financial Futures Exchange. It will become operational later this year and will be the first platform in Europe to trade RMB-denominated financial products.

There is confidence that this new exchange will facilitate the opening up of the Chinese capital market. But, despite all the buzz, China still keeps tight restrictions in place which prevent investors from having direct access to that market.





About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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