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The Chinese currency has risen 5.7 per cent this year to 6.5717 per dollar, offsetting most of last year’s decline. Photo: Cpressphoto
Opinion
Across The Border
by Karen Yeung
Across The Border
by Karen Yeung

Why Beijing’s tight grip on the economy is bad news for the yuan

This year’s rally in the yuan ended last week after the People’s Bank of China scrapped a reserve requirement on a derivative of the currency that was aimed at curbing depreciation.

Nevertheless, market players are confident Beijing will ensure there is no sharp reversal in the yuan’s direction before the 19th National People’s Congress of the Communist Party of China, scheduled to start on October 18.

It could be a very different story once the five-yearly gathering is over, however, according to analysts.

Setting the stage for China’s most important political event, President Xi Jinping said this week that stability was an absolute principle that needs to be dealt with using “strong hands”.

His comments appear to imply that the Communist party intends to keep tight control of the economy’s direction in the coming years as it strives to restructure state-owned enterprises, cut overcapacity and reduce risky borrowing in the shadow banking sector, analysts said.

The state will continue to play a big role in the corporate and financial sector
Wei Yao, chief China economist, Societe Generale

The composition of the new, top-ranking Central Committee and the Politburo Standing Committee, which will be revealed a week after the gathering, will indicate to what extent Xi may be able to further consolidate his already strong grip on power.

“The state will continue to play a big role in the corporate and financial sector. The benefit of having party control is it will keep stability in the financial system and the labour market,” said Wei Yao, chief China economist at Societe Generale.

Because of the implementation of strict capital controls and the weaker US dollar this year, the yuan has performed strongly, accelerating in this quarter. The Chinese currency has risen 5.7 per cent this year to 6.5717 per dollar, offsetting most of last year’s decline.

But depreciation pressure is expected to return once all the official events marking the National Party Congress are out of the way. The government’s obsession with ensuring stability has averted a banking crisis for now, but it has also brought on many side effects that will ultimately lead to slower economic growth and a weaker currency, analysts said.

“At the end of the day, the question is whether the economy will be more efficient, less reliant on debt, and whether the corporate sector will truly be more profitable,” Yao said.

With market forces playing only a limited role in reforms, the efforts to establish mixed-ownership of state-owned enterprises in recent years have not led to an increase in productivity, according to Nathan Chow, an economist at DBS Bank.

And the debt-swap equity programme, aimed at cleaning up the country’s bad debt, has failed to attract private investors to become new equity shareholders because the government was reluctant to let market forces set the price of equity.

The economy will face a bumpy road and the currency can’t be too strong or it will hurt exporters
Nathan Chow, economist, DBS Bank

China is expected to continue its crackdown on the shadow-banking sector after the Party Congress, which will reduce credit and investment in the economy, and ultimately lead to slower economic growth. A raft of disappointing Chinese economic data in August, including retail sales, manufacturing and investments figures that came in below expectations, underscores concerns about the economic outlook.

“The progress of reforms has not gone far enough so there will continue to be tight regulation. The economy will face a bumpy road and the currency can’t be too strong or it will hurt exporters,” Chow said.

Adding to pressure on the yuan, analysts expect to see a reversal of this year’s slide in the dollar, which was triggered by a collapse in confidence in the Trump administration’s ability to implement its economic agenda.

Expectations for the US Federal Reserve to start reducing its balance sheet and to raise interest rates will boost the greenback versus the yuan and other Asian currencies, analysts said.

Meanwhile, China’s capital controls are making mainland companies and ordinary citizens more wary, causing them to withdraw money and hold savings outside the country, analysts said.

“Mainland corporates have earnings that were taken out of China, and if they are unsure about capital controls, it makes them less likely to bring the money back onshore,” said Kenrick Leung, investment director at Amundi. “They don’t want to remit funds back, so you’ve got this big pool of liquidity that is sitting in Hong Kong and keeping rates low.”

Amundi, which has over€1 trillion (US$1.20 trillion) of assets under management, forecasts China’s GDP will grow by 6.7 per cent this year before slowing to 6.6 per cent in 2018.

The yuan is predicted to drop to 6.65 per dollar by the end of the year and to 6.71 by the second quarter of 2018, according to the median estimate of economists in a Bloomberg survey.

This article appeared in the South China Morning Post print edition as: Yuan rally falters ahead of party talks
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