China May Pay A High Price For SDR Push

China faces a risk in entering the SDR because in order to enter the currency basket, it must open the capital account. Doing so changes monetary policy, forcing China to swap either independent monetary policy or stable exchange rates in the famous trilemma. Faced with an economic slowdown, China does not want to lose control over monetary policy. A depreciation in the yuan could ignite anti-China sentiment in the United States. Backtracking on opening the capital account would slam the door on the SDR and also be a step back in the reform push.

An article in the Economic Observer (人民币多空博弈正酣) looks at the growing battle in the currency market, with bulls and bears battling over the direction of the yuan. Although the central bank is likely to win in the long-run (their view), the short-term will be volatile.

One major factor is the push to have the yuan added to the SDR basket. China must allow greater capital flows, but this brings up the trilemma. A country can choose two of the three: fixed exchanged rates, capital mobility and independent monetary policy. China has chosen the first and third for decades, but if it wants to enter the SDR, it must abandon 1 or 3 for number 2. If China were to give up monetary policy, it might have to raise interest rates amid the economic slowdown to defend the value of the yuan. Given that China has massive foreign currency reserves, China might be able to buy its way out of the trilemma for a time by spending down reserves to maintain currency stability, such as during the 2016 presidential election in the United States. The point is, if there's a problem, China will have to pay a steeper price if it wants to stabilize the exchange rate while opening the capital account.

However, there's evidence that the PBOC has another weapon that it has already used to fight depreciation pressure: higher interest rates on deposits.

The EO says for the time being, it seems China is choosing to force up market rates to defend the exchange rate. This can be seen in latest interest rate cut where the PBOC raised the deposit ceiling. Following the latest policy change, banks can offer higher deposit rates than before. Banks did just that back in November when rates were cut and the deposit ceiling was raised. See Deposit Competition Begins: Some Chinese Banks Hike Long Term Deposit Rates

Once again, Chinese banks are hiking interest rates. Here's an article out today: 央行降息湖南多家银行存款利率上浮 最高1.3倍. The PBOC cuts rates and Hunan banks hike deposit rates, with the highest at 1.3 times the benchmark rate. (The prior ceiling was 1.3 times; the new ceiling is 1.5 times)
Last November 22, the central bank cut interest rates for the first time after a lapse of 28 months, and decided to expand the floating range of deposit rates from 1.1 times to 1.2 times. Subsequently, Changsha banks deposit rates quickly, "a float to the top," started a savings battle, after which the five lines also had calm himself, had all of a floating ceiling.

Also this year, on March 1 the central bank cut interest rates again, and the deposit rate floating range expanded from 1.2 times to 1.3 times. Interest rates on the first day, Changsha Bank, city commercial banks and other Huarong Xiangjiang River that is a high-profile announcement, the deposit rate will be "a floating to the top." Later, as the stock market more and more fire, banks Lanchu pressure increasing, Bank, Bank of China and a number of state-owned banks have begun to "stretch live", and then added to the "one floating to the top," the bank ranks.

Yesterday, the central bank cut interest rates three times shot, this time is the introduction of "medicine", announced the deposit rate floating range expanded from 1.3 times to 1.5 times the previous. This time, the bank will, as always, eager to "float to the top," it?
The chart below is from the article. The red numbers are interest rates that have increased. The banks are listed in the top row, with the central bank's benchmarks on the far left(央行). The big 5 are to the right, followed by Postal Savings, then the big listed banks, then smaller banks. The first rate is the demand deposit rate. Below that is the 3-month, 6-month, 1-, 2-, 3-, and 5-year rates.
Wondering why bank stocks haven't rallied in the A-share market? Free market deposit rates may have already arrived as many banks cannot lift rates to the top of the new ceiling due to the cost. Furthermore, one analyst from China Merchants thinks the next rate cut will result in the elimination of the deposit ceiling entirely:
"Most of the bank's profits from deposit and loan spreads, the high current cost of capital, coupled with non-performing rate of bank loans has increased, resulting in deposit and lending margins narrowed further, the banks lack 'a floating top' power. "Changsha, a state-owned bank, a senior expert said.

Meanwhile, a senior analyst at China Merchants Bank Financial Markets Department Liu Dongliang analysis, taking into account the ratio of deposit interest rates go up 1.5 times, the interest rate market is entering "the last kilometer" sprint stage, is expected to announce at the next rate cut is likely to release the deposit interest rate ceiling.
China's reform effort is buying it time, lifting deposit rates at a crucial moment of monetary reform amid an economic slowdown, but if rates have peaked or are close to peaking because banks can no longer increase deposit rates, pressure on the exchange rate can commence as soon as conditions are ripe. The central bank could lose control of interest rates, or monetary policy could lose effectiveness if the push for internationalization of the RMB proceeds too quickly.

As a result, the EO wonders if now is really the best time for opening the capital account:
However, capital outflows, under domestic and international financial situation is becoming increasingly complex background, fully opening the door to capital may not be wise.
Chinese economists are worried about depreciation expectations setting in:
CASS World Economics and Political Research Office Director Zhang Bin says the RMB appreciation or depreciation depends on the intensity of capital account liberalization. If the current account surplus is larger than capital account deficit, it will support RMB appreciation. If the capital account is opened while the monetary authorities reduce efforts to maintain a stable exchange rate, coupled with the Chinese private sector's diversification of assets, it will create downward pressure on the yuan. "Recommend shifting policy from maintaining a stable RMB exchange rate to a relatively stable exchange rate. Want to ensure that the RMB exchange rate can be controlled. For a long time the market has been accustomed to the RMB rising against the US dollar, shifting to a trend of weakness versus the US dollar will leave the market unprepared, easy to breed fear, and one-way depreciation expectations are formed, resulting in difficulties in curbing a panic depreciation. Can choose to deepen the reform of the RMB exchange rate formation mechanism." Ding Zhijie said.
The EO concludes with this:
On the eve of ten years of currency reform, with $ 3.73 trillion in foreign exchange reserves (as of March 2015), the central bank desires to reverse exchange rate depreciation expectations and issue a "strong yuan" signal. Then, see how the market digests the signals.
The PBOC will be subject to market discipline. Fighting Mr. Market is expensive and as every central bank eventually learns, Mr. Market always wins in the end.

Related: China Adopts IMF Accounting Practice in Reserve-Currency Push

No comments:

Post a Comment