“The most important factor is confidence, both globally and within China,” said one 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.”
Although PBoC officials knew that changing the way the central bank set the daily exchange-rate “fix” would unleash some pent-up depreciation pressure, it underestimated the intensity of the market reaction, analysts say.
A move that might have been expected to produce a 5 per cent downward adjustment quickly threatened to spark a 10 or 20 per cent rout within a matter of days. Such an uncontrolled devaluation could have undermined the broader financial system by inciting investors to dump renminbi assets en masse.
The International Monetary Fund is likely to address exchange-rate volatility, among other financial risks, when David Lipton, deputy managing director, presents the fund’s annual financial stability report on China on Tuesday in Beijing.
While the timing of the August move was probably linked to the IMF’s then-pending decision on whether to designate the renminbi as an official reserve currency, it also coincided with dramatic turmoil in the country’sstock market, adding to investor jitters.
That put the PBoC in the position of scrambling to curb renminbi weakness only days after announcing a policy ostensibly intended to reduce government interference in the market. The result was widespread confusion among investors about the central bank’s true intentions, a mood exacerbated by the PBoC’s poor communication.
Other PBoC advisers argue that intervention to stabilise the renminbi-dollar rate is unnecessary. “Some Chinese economists fear any movement of the exchange rate,” says one adviser. “They fear that if it falls 2 per cent, then it will fall 10 per cent — and if it falls 10 per cent then it will fall 100 per cent."
The adviser argues that given China’s consistently strong trade surpluses and low external debt levels, the Chinese currency should remain relatively stable against the dollar. “If you take the whole balance of payments picture into consideration, the renminbi will stabilise quite easily and rebound,” he says.
Critics say PBoC spending on intervention has been a waste because it has only delayed further weakness in the renminbi. Economists broadly agree that downward pressure is likely to resume once the timing of the Federal Reserve’s next interest-rate rise becomes clearer. Total reserves fell to $3.19tn last month, down from a peak of $3.99tn in June 2014. Even with intervention, the renminbi has lost 5.3 per cent since the devaluation last August.
The PBoC has rejected criticism that it has abandoned its commitment to a market-based exchange rate. Officials believe that with the economy now 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.”