Why is China so afraid of US Fed’s interest rate increase?
Just look at what happened after the last time the Fed raised rates
Chinese authorities are putting on a brave face about possible interest rate increase by the US Federal Reserve on Wednesday, but it is probably the worst-kept secret in Beijing that the nation’s policymakers are anxiously watching the fallout from the Fed’s much anticipated decision.
The Fed is tipped to raise interest rates at the end of its two-day policy meeting on Wednesday.
Watch: US Fed increases interest rate by 25 basis points
Beijing has a good reason to be nervous because of happened to China after the Fed’s last interest rate rise on December 16, 2015 – its first increase for nine years – even though it can be argued that the Fed’s 0.25 per cent rise was not the only reason for what happened next ...
1. Yuan depreciation against US dollar deepened
The Chinese yuan’s depreciation against the US dollar noticeably accelerated after the Fed rate rise, even though the depreciation process had started as early as 2014 – in tandem with talks by Fed officials about the possibility of the US central bank tapering, or gradually reducing, its securities purchases.
While China’s own missteps – including the surprising devaluation of the yuan by nearly 2 per cent in August 2015 – also contributed to renminbi weakening, the Fed’s December 16 rate rise clearly worsened China’s capital flight and quickened the pace of the yuan’s depreciation.
The fall of yuan against the dollar on the offshore market was faster than on the onshore market, forcing Beijing to act to squeeze liquidity in the offshore yuan market.
The yuan has depreciated about 6 per cent against the US dollar since the last Fed rate move.
2. China forex reserves shrank quickly
China’s foreign exchange reserves dropped by a record high of US$107.9 billion in December 2015 when the Fed raised US interest rates. The reserves dropped by another US$99.4 billion in January 2016.
The depletion of China’s reserves slowed in the spring and summer, partly because the Fed had held the dollar policy rate unchanged and also because Beijing worked hard to sooth concerns about the country’s economic and financial health. But the fall in China’s reserves has been gaining speed again in recent weeks.
The fall in reserves in November was the largest single monthly fall since January.
3. China’s stock market plunged
In the trading days after last December’s Fed rate rise, China’s stock market kept falling despite Beijing’s efforts to support stock prices with public funds.
The stock price fall was so bad that it prompted the China Securities Regulatory Commission – the stock market watchdog already under heavy pressure after a summer rout of stocks – to hastily launch a circuit breaker mechanism after the New Year.
The new mechanism triggered massive sell-offs and Beijing had to withdraw it after only four days of operation. Xiao Gang, the CSRC chairman, then stepped down.
The Shanghai stock market benchmark index lost about 25 per cent of its value in the six weeks following the Fed’s rate rise.
Up to now the index still remains 10 per cent lower than its level when the Fed decided to act.
4. Beijing started to reverse capital account opening process
Over the past year the Chinese government has tightened controls over capital outflows, making it more difficult for mainland companies to obtain foreign exchange.
According to unpublished rules seen by the South China Morning Post, China has also enhanced its regulatory examination of outbound remittances and halted approval for large overseas investment deals.
The yuan’s ambition to become a global currency has met some setbacks as offshore yuan markets have become smaller and less active, and the desire to use yuan in trade payments and settlements has weakened.
Watch: How the Fed rate hike impacts Asian markets