Real fight remains for China’s economy

After two years of uncertainty and volatility, China’s economy is in a sweet spot – for now. Its foreign exchange reserves have been expanding in the past six months, hitting a whopping US$3.6 trillion. The economy grew by 6.9 per cent in the first half of this year and the yuan has been rising steadily against the US dollar.

Financial outflows have slowed. A combination of improved trade and economic performance, and measures to control capital outflows have meant money and investment are moving back into China. How things have changed since two years ago when the US Federal Reserve cited China’s economy and the yuan as risk factors in holding off an interest rate hike.

The country’s economic policymakers have won a battle, but the real fight remains. If financial reforms and a free-floating yuan remain the long-term goals, then the strategic and calculated market interventions – along with their often opaque operations – may come back to haunt them.

Two years ago, Beijing was blamed for the market panic caused by the sudden yuan devaluation. While it appears to have given up such blatant market intervention, it has not necessarily allowed in greater market forces. Instead, capital controls have been strengthened. A so-called “counter-cyclical” factor has been added to the pricing model by which the People’s Bank of China, the country’s central bank, sets the yuan’s value.

Beijing argues it is letting in market forces in that the yuan’s daily rate is set for market makers by referencing its closing price to the US dollar and against a basket of currencies. The central bank will publish a mid-point price every trading day, and the yuan will be traded against the dollar within a 2 per cent band.