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Analysis

Dilemma over renminbi convertibility

Beijing, PBOC stabilising capital outflows

by Adam Cotter in Singapore

Mon 13 Feb 2017

Chinese authorities and official media have been on a public relations offensive to dispel concerns that the country’s foreign exchange reserves have fallen below a ‘psychological barrier’. In January, China’s reserves fell below $3tn for the first time in seven years. This represents a 25% drop since 2014. On the positive side, January’s decline of $12bn was far below consensus forecasts, and reserve levels are showing signs of stabilisation.

Zhou Xiaochuan, governor of the People’s Bank of China, has previously stated that China’s reserves were too large and ‘exceeded the reasonable level’. Although Beijing has taken measures to limit capital outflows, it hasn’t been defending the $3tn threshold at all costs. Nonetheless, further erosion of the world's largest reserve stockpile may prompt policy-makers to intensify such measures, and raises concern over further financial reform.

In the past, the Chinese authorities kept the renminbi undervalued to benefit manufacturing exports. Now they are spending billions to support the currency. The renminbi depreciated by nearly 7% against the dollar in 2016, the largest decline since 1994. This amounts to 5.8% in trade-weighted terms. This was caused, in part, by China's uncertain economic prospects, though recent trade figures go some way to allay these issues. Recent data show that China is enjoying a recovery in both domestic and overseas demand.

In January the renminbi stabilised significantly against the dollar, ending a three-month decline. This has led to a reduction in ‘panic buying’ of the dollar, reducing the fall in Chinese foreign exchange reserves. January’s decline suggests that some government-imposed capital outflow restrictions have worked.

Beijing has avoided drawing attention to itself since Donald Trump’s US election victory – during the presidential campaign, Trump promised to brand China a currency manipulator on his first day in office. Much of the speculation surrounding the renminbi stems from the lack of transparency which is typical of China’s policy-making. Following the release of data on the country’s reserves, the State Administration of Foreign Exchange issued a statement that was intended to stem the speculation. Yet the market is still not convinced by what policy-makers are saying.

Beijing’s dilemma is whether to accelerate or slow the process towards full convertibility of the renminbi. The central bank’s short-term focus has shifted from internationalisation of the renminbi to stabilising outflows and the exchange rate. A strong dollar has weakened the attractiveness of the renminbi, leading to a decline of nearly 30% in the international use of the currency in 2016. Despite the move to become part of the International Monetary Fund’s special drawing rights, the renminbi was ranked only sixth in terms of international currency usage in 2016.

Dollar strength, together with Beijing’s readiness to diversify its assets, has caused the renminbi to come under greater devaluation pressure. Much of Chinese savings is in domestic banks and real estate, meaning that even modest attempts to diversify assets could represent significant capital outflows. In 2016 China's net foreign financial assets increased to a record, growing by over $200bn, 12% higher than in 2015. Chinese firms have also been increasing their ownership of foreign assets.

Yet capital flight, driven by confiscation risk and domestic concerns over China’s economic outlook, is the principal factor behind outflows. President Xi Jinping has been consolidating power in the Communist party ahead of this autumn’s 19th party congress. Chinese people and organisations with large assets are trying to diversify their holdings while they can.

Adam Cotter is OMFIF’s Head of Asia and Chief Representative of the Asia office in Singapore.

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