The View

PBoC to use ‘constructive ambiguity’ in yuan decisions

PUBLISHED : Monday, 17 August, 2015, 11:56am
UPDATED : Tuesday, 18 August, 2015, 12:26am

By not telegraphing its intentions to devalue, then claiming its move had nothing to do with weakening the yuan, the People’s Bank of China veered from the modern-era path of ever-increasing central bank transparency.

Expect more surprises in the future. When China moves to a free-floating currency regime, policy risk and unpredictability will be among a limited number of tools at the PBOC’s disposal to protect the yuan from excessive appreciation.

There is a term for this approach, coined by Hong Kong’s former monetary chief, Joseph Yam, about a decade ago: constructive ambiguity.

The renminbi is not cheap by conventional measures. Indeed, it is slightly expensive on a purchasing power parity (PPP) basis.

The problem is that it would be trading well above its PPP, the same way other currencies routinely do, if it were not repressed. That’s just a no-brainer. What other major economy has huge trade surpluses, high growth and yields similar to Australia’s?

What China doesn’t have is a risk-free sovereign rating. And like Japan - another big economy hooked on mercantilism – it will probably be smart enough not to get one.

As it is, China just slides in with a solid investment grade sovereign bond rating of AA-. This is the same grade as that of Japan –which had to resort to a mammoth quantitative easing programme to puncture its growing reputation as a safe haven currency.

For sure, the yen only became a refuge because of special circumstances , i.e., an unusually severe financial crisis which led to zero interest rate policy (ZIRP) settings in Europe and the US.

Before this, the Bank of Japan was the only major central bank with a virtual ZIRP setting, which helped keep the yen lean and mean.

China, however, would not be able to play this how-low-can-you-go limbo game against the world’s other major central banks.

Let’s just imagine where the world will be in three to five years time – the expected time line for China’s to switch from a managed to a free-float currency regime.

The OECD will probably have weaned itself off ZIRP, but the rich world’s greying and mature economies cannot exactly be expected to be bouncing along at an inflationary gallop.

China’s economy, meanwhile, will still be growing at 5 per cent per annum, according to most projections.

Even if the consensus forecasts prove toppy, fundamentals point towards a higher rate of growth than its ageing superpower peers. This might not be particularly inflationary growth, but interest rate differentials with other major economies will almost certainly favour China.

A stronger currency is not all bad; besides anything else, there is a prestige factor involved. But the last thing Beijing wants, when it opens the gates, is for the renminbi to become one of the world’s hottest trades.

After all, only about a third of China’s exports are in the high-tech category. In comparison, Japan in the early 1980s had a high-tech export component of 60 percent. That should have made it easier for Japan to deal with the sharp appreciation of the yen that came with the 1985 Plaza Accord agreement.

It didn’t. Growth faltered and Tokyo resorted to slashing interest rates and recklessly expanding credit – leading to an asset bubble that burst in the 1990 stock market crash.

China will not repeat Japan’s mistakes. But unable to win the race to the bottom on rates, what else can the PBOC do to protect the country’s export market from excessive appreciation?

There are plenty of tricks of the trade, all of which are risky and interventionist.

The PBOC, for instance, can purchase dollars on the open market, just like Switzerland routinely snaps up euros to cap the Swissie’s appreciation. This again is not without political and economic risks, however, as the Swiss can attest.

There’s something else we should note about Switzerland’s currency management. Its central bank is full of surprises, in contrast to the fetishized transparency of the US Federal Reserve, the European Central Bank or the Reserve Bank of Australia.

Telegraghing every likely future move with earnest precision may not always be the best modus operandi for countries that attract yield chasers and/or safe haven investors.

It would not be surprising if the next-generation PBOC increasingly wields “constructive ambiguity” as a policy tool.