China should let yuan fall, says the latest economist to join call for central bank to change tack

Zhu Ning, finance professor at prestigious Tsinghua University, says central bank’s use of foreign exchange reserves to prop up yuan is unsustainable

PUBLISHED : Thursday, 05 January, 2017, 10:59am
UPDATED : Thursday, 05 January, 2017, 11:22pm

China should stop its heavy intervention in the yuan exchange rate and allow a one-off devaluation of the yuan, according to the finance professor at the prestigious Tsinghua University and author of China’s Guaranteed Bubble.

Zhu Ning has joined a small but growing group of economists in Beijing who believe the central bank should change its tactics with regard to the yuan.

In an interview with the South China Morning Post, Zhu, deputy director of the university’s National Institute of Financial Research, said the current approach adopted by the People’s Bank of China – namely using up foreign exchange reserves to prevent the yuan from falling sharply – was unsustainable.

“The yuan has lost more than 10 per cent [against the dollar] from its peak, but China’s foreign exchange reserves have lost almost 25 per cent,” Zhu said. “What can China do if the reserves keep shrinking ... if its reserves can’t meet current account payment requirements?”

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Zhu said a more feasible approach was to let the yuan fall as much as the marketpermitted.

“There may be overshooting, but the market will gradually correct itself,” Zhu said.

By letting market forces determine the exchange rate, China “can avoid the loss of forex reserves and send a signal that it is a market-oriented operation,” he said.

Zhu, whose book provides a systemic analysis of the country’s financial risks stemming from an implicit government guarantee of the banking system, state enterprises and local government debts, is the latest big-name economist to question Beijing’s ongoing exchange rate policy.

He joined Yu Yongding, a former monetary policy committee member, who has argued for years that the central bank should stop intervening in the foreign exchange market.

Zhu Baoliang, a government researcher at the State Information Centre, a think-tank affiliated with China’s economic planing agency, was quoted by Bloomberg as saying on Tuesday that China should allow a big yuan revaluation.

To be fair, their views are more academic arguments, and it is not known whether their comments will be accepted by China’s policymakers and lead to a change in stance over the yuan.

China’s central bank, meanwhile, is showing a reluctance to permit any dramatic fall in the value of the yuan.

The yuan exchange rate posted its biggest percentage gains in about a year in offshore trading on Wednesday over speculation that Beijing wanted a stable currency ahead of US President-elect Donald Trump’s inauguration.

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Over the longer term, the Chinese currency weakened 7 per cent against the US dollar last year – the largest decline since it reversed a 10-year appreciation in 2014, despite the fact that Beijing had used nearly 1 trillion dollars of foreign exchange reserves to bolster the currency since 2014.

Zhu said China would face grim challenges from capital outflows in 2017.

“Yuan depreciation and capital outflows will greatly hinder China’s efforts to keep financial stability and carry on with economic reforms,” Zhu said.

Meanwhile, China’s moves to strengthen capital flow control run the risk of turning foreign investors away and “leading to more trade friction with the United States” under the new Trump administration, he said.

A trade war is looming between China and the US as Peter Navarro, the author of Death by China, had been named by Trump to head the White House National Trade Council.

Such external challenges had come at a time when China’s financial risks at home were increasing, Zhu warned.

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The country’s economic growth was decelerating, its inflation rate was edging up, and the country’s overall debt, including public and private sector, had reached a dangerously high level of about 250 per cent of China’s gross domestic product, he said.

A lot of short-term debt had been borrowed to finance long-term investments, and the situation could turn ugly if the liquidity supply dried up, Zhu warned.

The bond market sell off at the end of 2016, caused by the Federal Reserve’s rate rise and exposed grey-area bond market operations, had shed light on the risks in China’s financial system, he said.

All this required a comprehensive reform or overhaul of the financial system, but Zhu said there would be no big changes until China’s top leadership reshuffle was completed at the end of 2017.