When it comes to economic challenges, is China more like 1990 Japan than 1997 Thailand?
Harvard professor may have picked wrong comparison
“Those looking for a rough outline of the Chinese economy’s future would be wise to revisit what happened in Thailand in 1997, when the collapse of the baht precipitated the Asian financial crisis.” Harvard University’s Professor Carmen Reinhart wrote last month in an article on “China’s incompatible goals”.
Reinhart, co-author of the critically acclaimed This Time is Different: Eight Centuries of Financial Folly, argued that “China’s commitment to keeping the exchange rate steady appears to be incompatible with its recent turn towards more accommodative monetary policies.”
If the People’s Bank of China (PBOC) “is to prioritise financial stability and commit to fulfilling its role as a lender of last resort, it may be preferable to accept that devaluation [is] inevitable – before the country’s foreign-exchange reserves are depleted”, she concludes.
While admitting “China in 2016 is different in many ways from Thailand in 1997”, Reinhart said there were “key similarities in their responses to ongoing capital outflows”.
She contends that while the natural monetary policy response, in any country, after a prolonged credit boom that typically leaves commercial banks with a “a mounting volume of non-performing loans”, is “to increase liquidity, lower interest rates” and even offer “direct assistance in the form of loans from the central bank” that can prove counterproductive.
If “confidence in the currency and the economy is faltering, foreign investors are pulling money out of the country and domestic residents are doing the same”, such policies, though seemingly logical, “almost always [result in] more capital flight and mounting reserve losses”, she wrote.
Capital controls, Reinhart argues, can buy time, noting “Thailand introduced controls on outflows in 1997” and that “China tightened its controls earlier this year”, but even when bolstered “by a large war chest of reserves” as in China’s case, this cannot reverse the trend.
But perhaps Reinhart is too pessimistic.
While she notes the PBOC’s “foreign-exchange reserves peaked in mid-2014” and have subsequently “diminished by 20 per cent”, Reinhart makes no reference to recent analysis by the Bank for International Settlements that concludes a key driver of yuan weakness and the drop in reserves was Chinese companies repaying US dollar-denominated debt.
Capital was not just blindly exiting mainland China, whereas in 1997, in large part, money that flowed out of Thailand just wanted out.
It is also notable that, as HSBC wrote last month, “China’s non-financial outward direct investment (ODI) flows increased by 10.1 per cent in 2015 and officially overtook what the country receives in inward foreign direct investment for the first time.”
Those are positive capital outflows and a world away from Thailand’s experience in 1997.
“With domestic savings higher than investment, China must export capital abroad,” HSBC said. “This creates a window of opportunity to make investments in assets that provide a long-term source of income.
“The rapid acceleration in China’s direct investment makes sense in the long term, as it can expect to make better returns than through accumulating foreign exchange reserves.”
In this vein, the ODI embedded in ChemChina’s US$43 billion deal in February for Switzerland’s seed and pesticides group Syngenta represents both a potential income stream into China and a tool in Beijing’s strategy to modernise Chinese agriculture over the next five years.
Although not a response to the Reinhart article, HSBC also provides an alternative view to the notion that more accommodative Chinese monetary policy and a stable exchange rate cannot coexist.
HSBC thinks China has room “to allow the exchange rate to fluctuate in increasingly larger magnitudes, while implementing some temporary measures that will help guide market expectations on the [yuan] to become more balanced”.
“This strategy will buy some time for market conditions to become more conducive for reforms,” the bank said. “Monetary policy easing can continue, complemented by fiscal stimulus to support the economy.”
Reforms and restructuring are also on the mind of Hong Kong-based Bank of Tokyo-Mitsubishi UFJ analyst Cliff Tan in the Japanese bank’s April foreign exchange outlook.
Viewing the late-1990s reforms of former Premier Zhu Rongji as “laying the foundation for China’s decade of miracle growth last decade, what is or is not happening with respect to restructuring this year promises to lay or not lay the foundation for the next season of growth (or lethargy)”, Tan wrote.
Noting the failure of Japanese policymakers to embrace the need for painful restructuring in the early 1990s, Tan asserts “the danger has never been Thailand 1997 for China, but Japan 1990”.
On balance, in looking for a comparison for China in 2016, might Reinhart have picked the right decade but the wrong country?