China’s exchange rate reform

Yu Yongding24 August 2015

IWEP Beijing

The RMB exchange rate before 11 Aug: from under valuation to overvaluation

贬值

the fixed central parity rate, market rate, and the gap

The movement of the exchange rate after 11 Aug

The daily fix and the closing price on previous day

1.9% depreci

ation

Closing price

Daily fix on

12 Aug

Undervaluation or overvaluation?

• Long-run Current account: undervalued• Short-run Capital account: overvalued• In the first half of 2015– Current account surplus: 152.17 bil USD– Capital account deficit: 161.92 bil USD– Reduction in FX and Error+ omission: 124.8 bil USD

• Twin surpluses no longer existent, capital account deficit>capital account deficit

• Devaluation pressure and devaluation expectations

Not only in China

• Analysts calculate that nearly $1tn of capital has flowed out of emerging markets over the past 13 months — roughly double the outflows during the financial crisis — which could threaten growth in EM economies.

• ft

Deflation and debt spiral?• 2012 q2 GDP growth rate below 8%• PPI has been falling for 41 month• CPI still positive but below 2%• 1997 PPI started to fall. 8 months later CPI entered the negative territory.• Prolonged deflation between 1997 to 2002 was attributable to the lack

exit mechanisms for failing enterprises• Recovery in 2002, due to the eventual elimination of overcapacity,

housing construction boom and rapid increasing in exports (two engines)• Has the economy reached the bottom? Growth of industrial profitability

has turned positive in the second quarter, other indicators show sign of improvement--destocking, PMI and so on. But it could be a blip only.

• I tend to think this round of slow-growth may last longer than expected (overcapacity, high-leverage, new growth engines?)

A simulation of corporate/GDP trajectories

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 20280

50

100

150

200

250

300

350

400

% 百分比

n=7% n=6.5% n=6%

Capital efficiency, growth, profitability, interest rate, inflation ， capital market development

The short term policy responses

• Further loosening of monetary and fiscal policy• There are still room for fiscal expansion• Capital market ?– The bungled stock exchanges– More IPO?

• Exchange rate policy ?– Contradicting to long term objectives– Foreign debt of corporates (how large it is?)

Risks, and policy options

• RMB devaluation expectations• Capital outflows• Self-fulfillment• Reform of the exchange rate regime lags behind

capital account liberalization• There are money options (from slow to radical

changes). Maybe, China should choose liberalize the exchange rate in one-go, while tightening what China still can tighten with regard to capital account to prevent a stampede in capital exodus

为了 SDR?

“ 可自由使用货币” ？

“无论在香港还是伦敦，银行家和金融界人士无不期待人民币正式成为储备货币。届时，涉及人民币的交易便会达到数万亿元，他们就可以从中受益。”－沈联涛

Thanks