Why worries about a sharp slide in the renminbi are overblown
Joe Zhang says China can effectively raise the value of its currency if it wants to, in response to jitters about the impact of a US interest rate hike. Yet it has made no such move – because it does not need to
Most China watchers have a very firm belief that the renminbi is significantly overvalued and that it is due to depreciate sharply at some stage, probably in the near future.
Their conviction grows as an interest rate hike by the US Federal Reserve becomes increasingly likely. Each release of economic data from China, and Beijing’s tightening of capital outflows, become extra reasons for the pessimists to reiterate their forecast.
However, this fervent belief is odd if one considers the glaring absence of a black market for foreign exchange in China. Recall that, in the 1970s through to the late 1990s, an active black market was a prominent phenomenon. The exchange rates often deviated 50 or even 100 per cent from the official rates as a result.
There was so much imbalance between demand for, and supply of, foreign exchange that, in 1980, the People’s Bank of China introduced a foreign exchange certificate as a rationing mechanism. Almost immediately, it became a separately traded asset class. Even employees of the central bank (like myself) had to resort to the black market to buy foreign exchange to fund overseas education or purchases of imported goods.
This dual-track currency regime faded away only when the renminbi started to strengthen in the early 2000s.
Today, China still controls the renminbi’s exchange rates and capital flows, but each individual Chinese citizen is allowed to buy US$50,000 a year from any bank. Moreover, if you want to buy more foreign currency, you can easily borrow the quota from your neighbours, friends and even total strangers. Indeed, many businesses inflate their import bills and under-invoice their exports in a bid to keep more foreign exchange outside China.
Many also send their money to overseas destinations through the acquisition of foreign businesses. These activities have led to all sorts of abnormalities in China’s data on balance of payments. While these factors fuel the pessimists’ forecasts, I see them as confirmation that the renminbi is rock solid, precisely because the pressure on it is being released every day.
It is a big mistake to assume that officials at the People’s Bank of China are totally unaware of the tricks smart merchants play to send capital overseas. But the fact that the regulators are not enforcing the controls is only because they do not have to, and do not want to.
And their half-hearted enforcement of rules is the only reason why a black market has not re-emerged and why there is only one set (rather than multiple sets) of exchange rates.
My interviews with a large number of businesspeople and consumers suggest that they encounter no real hurdles in accessing and transferring foreign exchange.
Some say they are put off by low returns in foreign countries. Many see merit in having some assets outside China. But, still, it is not a high priority for the vast majority of Chinese. Moreover, I feel that outside observers have grossly overstated Chinese people’s anxiety about the country’s political future.
The Fed may raise interest rates multiple times in the years ahead. But even if it were to double or triple its rates, it would still be just a small factor in the consideration of asset diversification for Chinese investors.
The same can be said about interest rate changes introduced by the People’s Bank of China. In Europe and the US, analysts pay attention to a rate change of 25 basis points, but in China, the central bank must lift or cut rates by 100 and even 200 basis points if it really expects to make a meaningful impact on the economy.
Why does China need a much bigger dose to jolt the market? Many other factors reinforce or offset the efficacy of central bank policies. For example, making tax collections or red tape slightly easier can benefit businesses much more than tinkering with the currency or the interest rates.
The renminbi may be overvalued. But it is easy to overstate the case. China may have lost some competitiveness to other developing countries, but to the envy of many of its trading partners, it still reports a trade surplus of between US$50 billion and US$60 billion each month, and that’s the surest proof of competitiveness in external trade. Controls or not, the renminbi has been the strongest major currency (even beating the US dollar) in the past 15 years.
Beijing can, if it wants to, tough it out on the currency front. For example, if it is willing to allow its foreign reserves to halve from the current level of US$3.5 trillion, it can send the renminbi significantly higher, thereby reversing all those gloomy forecasts. As the renminbi is increasingly adopted as a medium of exchange in China’s external trade, the foreign reserves are falling in relevance.
Short-sellers know this all too well: just because a stock is overvalued does not mean it will weaken next month or even next year. Similar to the fair valuation for a stock, a currency’s fair value is a very wide range, instead of a precise magic number.
Joe Zhang is a former manager at the People’s Bank of China and the chairman of China Smartpay Group