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Analysis
Protection from later Fed rate hike

Protection from later Fed rate hike

China seeking US foreign exchange commitment

by David Marsh

Wed 15 Jun 2016

China is suggesting to the US that leading countries strengthen their commitment to keeping international currencies stable as a way of guarding against an undue decline in the renminbi. However the Chinese overtures, while given a sympathetic hearing, are highly unlikely to gain any formal support in the volatile period around the British referendum on Europe and ahead of November’s US election.

Foreign exchange markets have been awash with rumours for months about some kind of agreement between the US and China to keep US interest rates and the dollar from rising too fast.

This would be part of an arrangement to maintain China’s steady economic liberalisation – including of capital flows – and prevent too steep a fall in the renminbi after its correction from levels last year widely seen as uncompetitively strong.

China wishes to go beyond the frequently reiterated international consensus that no country should engage in competitive devaluations – with Japan singled out in past months, in view of Tokyo’s wish to counter the relative strength of the yen.

The US Federal Reserve has been making clear that doubts about the Chinese slowdown have contributed to its caution on raising interest rates. Following the December 2015 increase in the federal funds rate for the first time since 2006, the Federal Open Market Committee is holding its latest two-day meeting on 14-15 June. After poorer-than-expected jobs data for May, no announcement on higher interest rates is expected today. But China would like some kind of protection from US tightening later in the year, a move that could hit the renminbi.

Speculation of an explicit US commitment to prevent a dollar overvaluation has been rife since a G20 finance ministers’ end-February meeting in Shanghai. But talk of a new ‘Plaza accord’ – similar to the dollar ceiling agreed in September 1985 in New York – appears wildly overdone. The Plaza meeting, following a 40% trade-weighted rise in the dollar between 1980 and 1985, sparked a 30% decline in the US currency in the ensuing four years. However, these movements were much larger than the dollar’s 2012-16 trade-weighted rise of 20%.

China would like to unveil enhanced efforts against disorderly currency movements at the G20 Hangzhou summit on 4-5 September. This will provide a curtain-raiser to the formal entry of the renminbi into the International Monetary Fund’s special drawing right on 1 October.

Around the same time, the Chinese authorities are likely to launch a borrowing platform in SDRs in China for domestic and international bond-issuers, boosting the SDR’s presence and offering Chinese mainland investors access to high-quality, largely foreign currency-denominated assets.

The renminbi’s SDR entry forms part of the Chinese commitment to a mixture of fiscal and monetary orthodoxy coupled with structural reforms and liberalisation, including a more market-orientated approach to the exchange rate. This dual policy is personified by Zhou Xiaochuan, governor of the People’s Bank of China, who has stayed on at the bank beyond the normal retirement age of 65, making him by far the longest-serving of the world’s premier central bank chiefs.

Zhou is expected to stay until his third five-year term ends in March 2018, when he will be 70. The Chinese authorities are likely to choose as Zhou’s successor a person with political as well as financial skills. Among the front-runners are understood to be Jiang Chaoliang and Guo Shuqing, respectively governor of the provinces of Jilin and Shandong, alternate member and member of the Communist party’s central committee.

Underlining the Beijing authorities’ worries about western views that their economic strategy is veering off course, the PBoC published a statement a fortnight ago pledging ‘unceasing commitment to the direction of market reform and increasing the exchange rate’s bidirectional flexibility’.

US interest rates and the Chinese currency’s oscillations have been high on the agenda of international financial meetings this year, including at last week’s US-China Strategic Dialogue in Beijing. The US is still a long way from acceding to Chinese suggestions that it might make a commitment to purchasing renminbi at times of stress through a mutual Federal Reserve-PBoC swap line. This is partly because of the renminbi’s lack of full convertibility – a characteristic the US accepts is unlikely to change soon on account of China’s policy of a ‘managed float’ for the currency.

The renminbi has fallen about 5% on a trade-weighted basis since its peak in November 2015. But this compares with appreciation of 5-6% a year in each of the previous three 12-month periods. Since end-2012, the renminbi has been one of the strongest major currencies – with the trade-weighted value up 13.7%, against gains of 20.4% for the dollar, 2.4% for sterling, 1.9% for the euro and a decline of 15% for the yen.

David Marsh is Managing Director of OMFIF.

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