China’s currency strategy

Alarming signs have returned on the Chinese economic front from the beginning of the year. The renminbi is trading below 7 yuan to the U.S. dollar and China’s foreign exchange reserves slipped below the $3 trillion threshold, reigniting jitters about Beijing’s ability to defend the world’s second largest economy against trade challenges from a hawkish new U.S. administration.

The Chinese currency policy has wavered ever since it announced changes to the way of calculating the value of the yuan on Aug. 11, 2015. Instead of fixing the yuan primarily to the U.S. dollar, it set the yuan against a basket of foreign currencies. Under the system, a strengthening in the dollar against other foreign currencies directly weakens the yuan.

Ever since the yuan became flexible, speculative funds attacked the Chinese currency for short-term profits every time the dollar strengthened.

Chinese companies delayed trade settlements and paid their foreign debt ahead. Individuals bought dollars up to their annual limit of $50,000, even borrowing under other people’s names to stack up the greenbacks. The central bank had to unload its dollar reserves in order to maintain equilibrium in the basket. As a result, it ended up losing $100 billion from its coffers every month.

Beijing found itself caught in its own trap by thinking the new currency system would work in its favor. Having been used to strict control over the capital market, authorities underestimated the potential speculative demand among the Chinese upon experiencing the riches available from a more liberal system.

But China is known for recalling military strategies from ancient days. One old tactic is to “make a sound in the east and then strike in the west.” When dealing with the Chinese, one is advised to look the opposite way as well.

From the scene on the eastern front, as we can say, some may wonder if authorities are seriously concerned about the pace of the yuan’s depreciation or erosion of their foreign exchange reserves. Although the country has lost $1 trillion from its reserves, integrity in its foreign exchange balance strengthened. China repaid over $500 billion in foreign debt. The ratio of short-term debt against the foreign exchange reserves also slipped to 24 percent as of the end of June 2016 from 34 percent in 2014.

Since regulations were toughened on speculation, profit-chasing dollar demand and capital flight from the country also has eased. The net outflow of $351.5 billion in 2015 partly due to early repayment of foreign debt has shifted to net inflows after Beijing banned institutions from repaying debt before its maturity in February 2016.

Trade settlements in dollars are being made on schedule. Foreign exchange reserves were reduced by $114.7 billion in October and November, but 70 percent of the loss is owed to the sharp fall in the euro and yen. The hype about the ebbing of China’s mighty foreign exchange reserves may have been much ado about nothing.

Events on the western front, to continue the metaphor, were less noisy but significant. The yuan, which steadily appreciated over the last decade, lost 14 percent in value since the change in the foreign exchange system in August 2015. The yuan’s direction was reversed. The People’s Bank of China emerged as a warrior battling to defend the yuan and fight capital flight. But what it actually ended up doing was devaluing the yuan by floating it against a stronger dollar.

While the world’s focus was entirely preoccupied with foreign capital leaving China, a weakening yuan became structural. Yet the export powerhouse has not gained much from its weaker currency due to the sluggishness in global demand. So what exactly was Beijing after through a weaker currency?

Stronger protection for the domestic market was the ultimate goal. The world’s most populated country remains a most promising market. The International Monetary Fund predicted 30 percent of global economic growth could come from the Chinese market by 2020. In other words, China still has business opportunities galore. The greatest number of them are in new growth sectors such as mobile devices and electric vehicles. That is why the Chinese market is important to businesses around the globe. A weaker currency could raise the frontiers against foreign invasion and keep the opportunities reserved for Chinese companies. That strategy is in tune with the broader agenda of strengthening domestic demand to fuel Chinese growth.

While China has been building higher walls around its borders through foreign exchange policy, Korea’s exports to China have plummeted for the third year in a row. Exports fell 11 percent year on year during the first 11 months of last year. The cheaper the yuan becomes, the harder it will be to make inroads to China. There is no easy solution in the bilateral context. Instead, Korean companies should endeavor to ride the shift in the global value chain from China to Southeast Asia. Korea should join forces with other export giants like Japan and Germany to fight against the new U.S. administration’s protectionist trade agenda and the subtle foreign-change protectionist agenda of Beijing.
Translation by the Korea JoongAng daily staff.

JoongAng Ilbo, Jan. 16, Page 29