What Happened to the Once Strong Renminbi Exchange Rate?
The renminbi has weakened against the US dollar over the past two years,drawing a great deal of attention and concern. The public keeps asking what happened to the renminbi and what is the outlook? Should people change their renminbi into US dollars or perhaps buy gold instead? We need to overcome our fears and take a rational view of the trends on the foreign exchange market. And we need to make a rational judgment of the renminbi's prospects over the next two years and taking apporiate response in coping with the changes of foreign exchange market.
Whether the renminbi strengthens or weakens is effectively determined by the public's confidence in China's economic growth and the prospects for a structural reform of the economy. Investors at home and abroad are effectively voting on this issues with buying and selling dollar or renminbi. The outcome of this vote decides the strength or weakness of the currency. If we look at the facts with rational manner,we can see that weaker public confidence is due to a continued weakening of the renminbi,a flat-lining of China's economic growth and difficult situation on foreign trade. Some scholars note that nearly 20 years before the 12th five-year plan (2011-2015),China's potential growth rate was around 10%. At the time of the 12th five-year plan it was around 7.6% and at the time of 13th five-year plan (2016-2020) it has been around 6.2%. It is difficult for China to return to its previous growth levels through the use of fiscal or monetary stimulus or government efforts to spur innovation. Market expectations toward the currency are easily changed. For example,if the exchange rate of the renminbi against the US dollar were a very strong 4 yuan to one dollar,many people would say they were optimistic about the currency. However,if the currency fell back to 8 yuan to the dollar,people would say they were pessimistic. Public expectations decide the exchange rate rather than renminbi purchasing power.
More importantly,public expectations are affected by government pledges and government credibility. This is a learning process for the public. People tend to have more confidence in government policies if they profit from believing in exchange rate policy pronouncements. The public tends to show greater confidence if it accepts government pronouncements and then profits by doing so. Conversely,if the public accepts government statements and suffers losses as a result,there will be many more doubters of what the government has to say. Government statements on the exchange rate have shifted from the renminbi exchange rate was "nearly balanced with two-way fluctuations" to having " no base for further depreciation" to there is no "base for long-term depreciation." The varied pledge from the officials is not helpful to establish a clear and certain expectation on exchange rate.
Credibility and the Asian Crisis
During the Asian financial crisis in 1997-1998,the Chinese government declared there would be no renminbi devaluation. To its credit,the government kept its word,and that gave it credibility. More recently,it has been another story entirely. Around 2014,government officials assured the public that the renminbi exchange rate was near equilibrium but with some mild two-way fluctuations. On August 8,2015,officials announced that the renminbi exchange rate mechanism was being reformed and that a small change in the exchange rate accompanied this reform. We have seen research reports since then saying that the renminbi would not weaken beyond 6.82 to the dollar while others state confidently that the currency will rebound in the second half of next year. Even if the public accepts the official pronouncements that there is no basis for the renminbi to weaken over the longer term,there is a perception that the currency could still lose ground. Those who have doubts about the currency's direction will take action to protect their interests.
Should the government put its priority on protecting the exchange rate,or its foreign exchange reserves,or asset prices? The government is presented with many conflicting choices. It may have to choose one and give up on others. Now the public and some specialists to a certain extent do not know exactly what the government's priorities are. This leads to great confusion.
Foreign exchange reserves are real assets accumulated over the many years since the reform and opening up policy began. It is impossible to recover these assets once they are lost. The exchange rate of course will fluctuate,and that is normal. If there is no way to protect the exchange rate and the foreign exchange reserves at the same time,it is my view that protecting the reserves should be the priority. If we review the events of the Asian financial crisis,Thailand exhausted its foreign exchange reserves in a failed effort to protect the exchange rate. The result of its actions was a loss of credibility. If we look at Western sanctions against Russia,Russia chose to safeguard its reserves instead of the ruble's exchange rate. Although the ruble fell sharply,it has recovered some of the lost ground over time. China doesn't face the same kind of extreme situation as Thailand or Russia but it is clear that at some point it may have to make a choice.
If we look at the events of the last two years,China's foreign exchange reserves have continued to shrink. The nation's foreign reserves fell from a peak of around US$4 trillion in June 2014 to US$3.84 trillion at the end of 2014 and US$3.47 trillion at the end of 2015. A conservative estimate puts the total at US$3 trillion by the end of 2016. If China's foreign exchange reserves fall below US$3 trillion,that would be an alarming development as far as the public is concerned. People may just extrapolate and say reserves will continue to decline and eventually fall below US$2 trillion in the next few years. Some specialists might argue that US$2 trillion would still be sufficient but many people may just compare that figure to the peak and draw their own conclusions about the nation's economic future. They may make their own decisions and protect their self-interest,regardless of what the government says.
Currently,there is a debate among academics as to whether the government should protect the exchange rate or property prices. And in the future there may be other controversies over policy choices. My view is there is no close relation between the renminbi exchange rate and domestic property prices. Either one of these can do fine without help from the other. But that still leaves us with the question of what should take priority - the exchange rate,foreign reserves,asset prices or capital controls? The final targets are unclear and the continued decline in the foreign reserves exacerbates public doubts over these policy objectives.
Asset Deployment: Less Investment at Home
The decline in foreign exchange reserves means capital outflows,and these could also be caused by asset deployment rather than a worried public. From 2014 till the present,China's foreign exchange reserves have fallen by about US$900 billion.