Yu Yongding: Don't Fear the Devaluation

Yu Yongding says the creeping depreciation of the yuan has many defects and the country should strengthen capital controls. He says it's not time to argue the pros and cons of renminbi depreciation, but to discuss how to prevent a market panic, to keep the market from overshooting, to minimize the fallout. He also says the currency should be allowed to float in a wider trading band.

He said the change in trend was back in early 2014 and that as reserves are drawn down, the central banks credibility will decline. Since the first devaluation in August, the yuan has been accumulating depreciation pressure, not dissipating it. He notes that most countries are reluctant to allow a currency depreciation, which leads to a crisis that necessitates currency depreciation.

Ultimately, he sees the risk of a massive depreciation as small due to China's reserves, but it should move quickly to end the pressure by allowing a larger depreciation.

A one-off depreciation has been the recommended policy here (due to expectations of a market depreciation) as well as the forecast given modern Chinese economic history.

Translation note: Google Translate seems to randomly alternate between depreciation (market driven) and devaluation (government choice). In nearly every case he means depreciation.
Plunge RMB devaluation pressure is suddenly set free

  "21st Century": the central bank since 2015, "8.11 exchange rate reform", the RMB against the US dollar appeared plunge. How you analyze the reasons for renminbi round plunge?

  Yu Yongding: RMB exchange rate trend change began in the first quarter of 2014. At that time China's current account, the capital account (including net errors and omissions) are surplus, but the depreciation of the yuan against the US dollar of around 3%. During this period, foreign exchange reserves increased by $ 125.8 billion, indicating that the first quarter of 2014 as a result of devaluation of the renminbi against the central bank to intervene in currency markets arbitrage trading. But after the second quarter of 2014, capital account deficit emerged in China. If you take into account the outflow of capital under the item "errors and omissions", in addition to the second quarter of 2015, since the third quarter of 2014, China has been in a state of balance of payments deficit. In other words, after the devaluation pressure from the market.

  Since China's central bank holds large foreign exchange reserves, the market believes the central bank to control the exchange rate. Thus, despite the international balance of payments caused by devaluation pressure, but the devaluation of the yuan did not appear large.

  Depreciation pressure either from the fundamentals, it can also come from the devaluation expectations. August 11, 2015, the central bank allows the exchange rate depreciated by 1.9 percent, the market for central bank policy is expected to safeguard stability shaken, devaluation is expected to soar. Depreciation is expected to soar over the existence of market reaction components. Devaluation of the renminbi is expected to accelerate capital outflows itself, thereby increasing the downward pressure. So the central bank and the market has been fighting to break the market expected devaluation.

  Since last August, the central bank's management of the exchange rate, many foreign investment banks are called "crawling peg." Bank of hope in this way to break the devaluation expectations. But it can only break the recent devaluation expectations, unable to break the medium and long term devaluation expectations, because the long-term depreciation is expected to be determined by the fundamentals, even if these expectations is a fundamental misinterpretation formation.

  Part of the capital depreciation of exchange rate stability can be suppressed by the expected impact of the outflow (outflow hiding in the current account in some), but may also be affected by another part of the accelerated depreciation of the expected impact of capital outflows. For example, the RMB exchange rate stability can fight short selling activity, but a stable exchange rate has reduced the cost of capital flight, and even encourage capital flight. Thus, the results of the exchange rate stability maintenance is likely to increase rather than decrease the devaluation pressure.

  If there is no improvement in economic fundamentals, while yet before the devaluation of the yuan to transfer funds more and more people will become more serious capital outflows, devaluation pressure will be increasing.

  Since last November, the central bank began to let the yuan depreciated slightly, after mid-December, the rate of depreciation have accelerated. Market began to speculate the central bank may allow a greater exchange rate devaluation, dormant for five months or so of depreciation is expected to re-active. Short offshore markets, other forms of capital outflows also with active, pressure increased sharply devalued.

  If central banks do not want to turn on the water, it must strongly intervene. In fact the central bank to do so, the yuan has stabilized. But this probably have to spend a lot of foreign exchange reserves. December 2015 China's foreign exchange reserves by more than $ 100 billion.

  So far, China and three more than one trillion US dollars of foreign exchange reserves, the central bank on the exchange rate still has a strong ability to control. But the central bank, if not August 13, 2015 after the exchange rate policy adjustments, if there is no significant improvement in the economic fundamentals, the market can not hear more "good story", with the reduction of foreign exchange reserves, the central bank holding stability credibility With the decline will be, capital outflows will be more fierce momentum. Over time, serious consequences.

  In short, the RMB is the sudden release of this round plunge since August 13, 2015 accumulated depreciation pressures. If devaluation pressure can not be released at any time, the yuan fell round is not the first, nor the last.

  Capital controls are an effective way to stabilize the financial markets

  "21st Century": In the presence of the expected depreciation of the RMB, the monetary authorities what measures can be taken?

  Yu Yongding: The consumption of large quantities of foreign exchange reserves to stabilize the exchange rate is not a good idea. First of all, 10 years, we have been emphasizing the strengthening exchange rate flexibility, an important part of China's financial reform is to let the market play a decisive role in the allocation of resources. Secondly, in order to maintain the independence of monetary policy, we must make a choice between capital controls and exchange rate fluctuations (of course, there is a matter of degree). Finally, exchange rate stability maintenance consume a lot of foreign exchange reserves, the cost is too high, there are also questions on sustainability.

  Faced with the current situation, in the exchange rate policy and institutional aspects, in theory, there are three choices: let the yuan float completely free (general national practice), announced that the RMB peg to the dollar does not depreciate (1998 Chinese practices during the Asian financial crisis), managed floating (including the "crawling peg" peg to a basket of currencies, etc., and pegged to a basket of currencies there are many different specific practices).

  Apart from adjusting the exchange rate policy, exchange rate regime, another very important measure is to strengthen capital controls. Many "crawling peg" defects, should be abandoned. The central bank research department with reference to a basket of currencies. This may be a better way, but I do not know the details of difficult comment. I and several colleagues presented some of their ideas, the basic idea is to increase the flexibility of the exchange rate as possible. The specific approach is to let the yuan pegged to wide fluctuations of the currency basket. We have published an article on January 18, which has done a more detailed discussion.

  Given that many of the current system defects, capital controls is an effective way to stabilize the financial markets. After vigorously publicize and promote capital account liberalization for many years, to re-strengthen capital controls is regrettable. But we may not have a better choice. A series of regulatory measures currently taken by the central bank, to comment on the details. Bank of the situation and strengthen capital controls direction is correct. But for the existing rules do not change easily, it is important strictly enforce the existing control measures.

  How to avoid the offshore market becoming a speculator's paradise?

  "21st Century": the central bank has taken various measures to intervene in currency markets, particularly the behavior of short offshore renminbi market. How do you evaluate this?

  Yu Yongding: short selling activities offshore renminbi market active. In a large number of central bank intervention to maintain exchange rate stability, the short sellers profit is lost nationals, short selling activity itself will increase the downward pressure on the yuan.

  Some things that happened during the Asian financial crisis, Hong Kong is now being repeated. Then speculators "short selling" Hong Kong dollars, the Hong Kong monetary authorities of Hong Kong by allowing inter-bank lending interest rates soared to punish speculators, to defend Hong Kong dollars. The central bank should learn from the successful experience of Hong Kong that year. If maintaining exchange rate stability as a prerequisite for the central bank to do so is entirely logical. How things will develop, look up the history of Hong Kong that year to roughly clear. China already has large foreign exchange reserves, plus some now essentially measures to strengthen capital controls, the central bank has made to counter this victory is no problem. However, if China's economic fundamentals have not fundamentally changed, the central bank still perform exchange rate stability maintenance policy, speculators even temporarily toys, the future will come back.

  In the offshore market with financial institutions abroad by Chinese renminbi to buy the same, reducing the supply of offshore renminbi market, improve the RMB borrowing costs are an effective way to suppress the offshore renminbi devaluation.

  But do not forget that, since 2009, the central bank has been trying to promote the development of the offshore market. If, as the mass market, "China's central bank has issued a notice on the part of foreign banks, to suspend its overseas renminbi business to participate in the line of cross-border renminbi business purchase and sale until the end of March next year." Future development of the offshore market will be affected is not hard to imagine. In addition, the side effects of these practices in place, whether you can continue deserves further study. There will be "press the gourd, dipper float" phenomenon worth studying.

  Offshore market turmoil, again, China must solve the economic reform, financial market reform, exchange rate system reform and other issues, the RMB internationalization can be sustained and healthy development of the offshore market can really help China Financial Asset Allocation optimization rather than become a paradise for speculators. Now many of the issues on the offshore market is actually pushing ourselves too eager RMB internationalization and capital account liberalization caused. In this turmoil is likely to be the process of internationalization of the RMB will enter the low tide mark.

  Currently, reports on the offshore market in Hong Kong more. Such as China Taiwan, Singapore, the situation of how we should be concerned about in other places. In addition, the offshore renminbi market interest rates rose through what mechanism shore money market interest rates and other market influence, as well as two markets will affect each other and other issues caused by the need for further research. I am not in the first line, the inconvenience of the operational details to make further comment. But we should be highly concerned about the central bank's short selling activities offshore renminbi suppression measures would HK and what impact the financial stability of Hong Kong.

  Overcome the "devaluation phobia"

  "21st Century": Some people asked devaluation will promote increased exports, may I ask how you look at the pros and cons of RMB devaluation?

  Yu Yongding: Any country large depreciation of the exchange rate will bring four issues: inflation, corporate debt burden (in yuan terms) increased, Bank currency mismatch (RMB assets, US dollar liabilities) and sovereign debt.

  The market is generally more concerned about corporate debt issues. Over the past year, Chinese enterprises to actively deleveraging. Corporate debt pressure should have been reduced. In addition, other problems are not serious now, and some simply do not exist.

  Everyone seems to have a sense of fear devaluation. In fact, in other countries, exchange rate fluctuations are commonplace. Currency devaluation is certainly an adverse impact on China's stock market and other capital markets, would cause panic and overshoot at the beginning, but as the currency depreciation, asset prices cheaper, the money will flow back.

  As long as the fundamentals have not a big problem, the exchange rate depreciation, and even a big depreciation will not cause the financial crisis and the economic crisis. On the contrary, in many countries was the result of the crisis, largely due to the reluctance to devaluation. A crisis erupts and the currency has no choice but to devalue.

  China is a large manufacturing and exporting countries, the benefits of the devaluation on exports is not self-evident. Of course, we should not exaggerate this benefit. 2016 China's monetary policy will be further relaxed, if maintaining exchange rate stability, capital outflow is inevitable, the central bank would be difficult to implement loose monetary policy, even if the central bank can hedge, but still difficult to solve the classic Mundell trilemma problem.

  Then we need to overcome the "fear of appreciation" and now we need to overcome the "fear of devaluation." Given China's economic fundamentals are still relatively good, it is difficult to envisage a substantial devaluation of the RMB will. Even "overshoot" occurs, China has capital controls that last barrier to maintain financial stability in China.

  Now need to be discussed, not devaluation of the pros and cons, but how to avoid devaluation led to panic in the market, overshoot, minimize the negative impact of the devaluation.

  Devaluation, may indeed lead to a strong international response, some countries may even attack China launched the "currency war." We must explain confidently, devaluation is the result of market forces, not the central bank manipulation of the results of China's attack is completely unjustified. China should not only patiently explained his policy, but should actively participate in regional or global financial and monetary cooperation, strengthen coordination with other countries, macroeconomic policies and exchange rate policies.

Sina: 余永定:汇率管理爬行盯住缺陷多 应加强资本管制

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