CHINA’s central bank has burnt through nearly half a trillion dollars in foreign reserves to support its currency since August, despite criticism that it has betrayed its commitment to let market forces drive the exchange rate.
Sources close to the central bank said the intervention, while costly, had been necessary to maintain economic confidence and prevent a disorderly depreciation that could have had ripple effects far beyond the currency.
The People’s Bank of China (PBoC) has spent about $473bn of its foreign exchange reserves since it surprised global markets last August by changing the way it set its daily guidance rate for the currency, according to Financial Times estimates based on official data.
Sources close to the central bank said the intervention, while costly, had been necessary to maintain economic confidence and prevent a disorderly renminbi depreciation that could have had ripple effects far beyond the currency
Fears that China would permit or actively encourage a sharp devaluation led to a wave of renminbi selling after the move.
“The most important factor is confidence, both globally and within China,” said a central bank official. “The cost of intervention in terms of reserves has been high, but this policy can’t be evaluated just in terms of numbers. Once confidence is lost it can’t be easily restored. Then a lot of bad things can happen.”
PBoC officials knew that changing the way the central bank set the daily ‘fix’ would unleash pent-up depreciation pressure, but they underestimated the intensity of the market reaction, according to analysts.
A move that might have been expected to produce a five per cent downward adjustment quickly threatened to spark a 10 or 20pc rout in a matter of days. Such an uncontrolled devaluation could have undermined the broader financial system by inciting investors to dump renminbi assets en masse.
While the timing of last year’s move was probably linked to the IMF’s then-pending decision on whether to designate the renminbi an official reserve currency, it also coincided with dramatic turmoil in the Chinese stock market, adding to investor jitters.
That put the PBoC in the position of scrambling to curb renminbi weakness days after announcing a policy ostensibly intended to reduce government interference in the market. Resulting widespread confusion among investors about the central bank’s true intentions was exacerbated by the PBoC’s poor communication.
Not all PBoC advisers consider intervention to stabilise the renminbi-dollar rate necessary. “Some Chinese economists fear any movement of the exchange rate,” said one. “They fear that if it falls two per cent, then it will fall 10pc – and if it falls 10pc then it will fall 100pc.”
Given China’s consistently strong trade surpluses and low external debt levels, the currency should remain relatively stable against the dollar, the adviser added. “If you take the whole balance of payments picture into consideration, the renminbi will stabilise quite easily and rebound.”
For the critics PBoC spending on intervention has only delayed further weakness in the renminbi. Economists broadly agree that downward pressure is likely to resume once the timing of the US Federal Reserve’s next interest rate rise becomes clearer.
Reserves fell to $3.19tn last month, down from a peak of $3.99tn in June 2014. With intervention, the renminbi has lost 5.3pc since the devaluation last August.
The PBoC has rejected criticism that it has abandoned its commitment to a market-based exchange rate. Officials have said that with the economy showing signs of stabilisation, further depreciation will be modest and will not spark general panic.
“Whenever there are signs of weakness in the economy, policymakers will quickly worry about maintaining stability,” said the official. “It doesn’t mean we’re giving up on reform.”
Fixed-asset investment in China grew at its slowest for 16 years in the first five months of 2016 as private companies held off spending and left the state sector to keep the economy humming, writes Lucy Hornby in Beijing.
The figures could weigh on China’s ability to hit its economic growth in line with its annual target this quarter. Beijing targets average annual economic growth of 6.5pc until 2020, and reported 6.7pc year-on-year growth in the first quarter.