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Analysis
Renminbi rebalancing signals reform urgency

Renminbi rebalancing signals reform urgency

China’s reserve plan sharpens Beijing policy dilemma 

by Marsha Vande Berg

Fri 21 Aug 2015

China intends to see its strategy to bring about a two-reserve currency world built around the dollar and the renminbi through to completion. Chinese financial market volatility and policy uncertainty in the past few weeks likely mark only the beginning of a longer-term trend as China rebalances its continent-sized economy away from investment towards consumption.

The People’s Bank of China has made a number of significant interventions, including setting interest rates at a record low, a ban on share sales by major investors to stop the stock market rout and measures to depreciate the currency by loosening the dollar peg.

This combination has reignited international criticism that, as domestic growth slows, Beijing’s mercantilist interests are taking priority over reforms. Amid general falls in emerging market currencies, investors are worried about the prospect of a regional, if not global, ‘currency war’, as well as about strengthening deflationary pressures.

The International Monetary Fund has weighed into the debate, declaring it believes China’s currency is not undervalued. This is a key plank in the institution’s pending decision whether to include the renminbi in the Special Drawing Right, along with the dollar, yen, euro and sterling. Joining the SDR – the currency basket for pricing the IMF’s own lending activities – would signal the Chinese currency had formally become a reserve currency.

The IMF’s board has been expected to announce its decision on the renminbi in the autumn. It’s likely there will be an extension until September 2016 – shortly before China’s President Xi Jinping convenes G-20 government leaders in China. An extension would give Beijing more time to prove that what it says about reforms is true, but there are questions over the substance and the timing of the authorities’ recent actions.

Optimists voice support for the PBoC’s publicly stated commitment to give a greater role to market forces. Zhou Xiaochuan, the PBoC governor and a known reformer, says this policy is behind the move to let the renminbi depreciate. But other more critical voices say Beijing is sacrificing market-based adjustments to the greater priority of countering slower growth and higher capital outflows

If China is to fulfil its wish to become a global economic leader, it must take steps to become a market-based economy through reforms that become a permanent part of the system.

China needs to gain international credibility as an economic partner, an area where it may have lost ground in recent weeks. Beijing’s chances of success will grow if the government shows that establishing the renminbi’s value based on market forces is the beginning – not the end – of a longer-term process.

Marsha Vande Berg is senior fellow, Program on International Financial Systems at Harvard University and a member of the OMFIF Advisory Board

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