China's Hand-of-State Tightens Grip on Market With Yuan MoveBy and
‘Old habits die hard’ for regulators, Llewellyn’s Jones says
Steady yuan may provide stability needed for other reforms
Chalk up another win for the visible hand in China’s markets over the principle of the private sector determining prices.
A move by authorities to smooth out daily changes in the yuan’s fixing versus the dollar, taken on its own, suggests a shift away from any eventual float of the currency. The news comes in a week when officials were suspected of having intervened in the stock market to limit damage to sentiment after Moody’s Investors Service downgraded China’s sovereign credit rating.
Both developments underscore the importance the Communist Party leadership places on specific outcomes, rather than the embrace of free markets that Western nations once pressed on China. President Xi Jinping has every interest in avoiding turmoil in the currency and equity markets this year as he oversees a critical reshuffle of top officials.
While relatively minor, the change “is surely a negative step for financial openness,” said George Magnus, an associate at Oxford University’s China Centre and former adviser at UBS Group AG. It’s “another step by Xi Jinping and the leadership to exert control where the deference to market forces was making at least limited headway.”
Limiting volatility in stocks and the yuan could give policy makers freer rein to take on deleveraging, with regulators seeking to pare back a shadow banking industry that’s contributed to booming prices for bonds and property in recent years. Moody’s itself cited China’s capital controls as one reason for giving the lowered debt rating a “stable” outlook.
A key question for China watchers is the degree to which the Communist leadership over the long run intends to embrace the private sector setting prices. In a key plenum in late 2013, the party pledged to make markets “decisive” in allocating resources across the economy. Yet that gathering came only a year after Xi took over as general secretary, and some China watchers now question the degree to which that pledge reflected his views.
For now, Xi needs to avoid extraneous events such as market turmoil or a resumption of economic hard-landing fears to unsettle his plans for the party’s leadership conclave later this year. The party at that session determines who sits on its top bodies for the next several years.
“The impetus to ensure market stability from various channels -- including the fixing -- is a policy priority, bearing in mind the upcoming party congress later this year,” said Christy Tan, head of markets strategy and research for Asia at National Australia Bank Ltd. in Hong Kong.
The yuan fixing tweak being considered comes ahead of a Federal Reserve meeting next month, with officials there hinting conditions are ripe for another boost to borrowing costs. The prospect for yuan weakness in the face of a continued dollar rally may also help explain the PBOC’s shift.
“The narrowing rate differential between the PBOC and Fed is a key driver of yuan weakness and outflows,” Bloomberg Intelligence’s Chief Asia Economist Tom Orlik wrote on a live blog Friday. “In the last few months we’ve seen the PBOC take a number of moves to offset that pressure,” with this latest step “another move in the same direction.”
PBOC officials, led by Governor Zhou Xiaochuan, had for years promoted liberalization of the yuan, trying to boost its role in the global financial system. In 2015, the International Monetary Fund approved it as an official reserve currency, deciding the yuan met the standard of being “freely usable.” Weeks later, Chinese officials squeezed a budding yuan market in Hong Kong to deter speculators, a move that crippled interest in offshore deposits and yuan-bond issuance in the territory.
Friday’s move “signals that politics are playing a larger role than markets in the fixing -- at least at the moment,” said Alex Wolf, a Hong Kong-based emerging markets economist at Standard Life Investments Ltd., who previously worked at the U.S. State Department. “Since the U.S. election there has been an effort to re-anchor the yuan-dollar rate.”
The planned new formula has yet to be put in place, so any effect on the exchange rate is unclear. While the Group of Seven had for years pressed China to adopt greater market determination for its currency, the Trump administration instead put a premium on avoiding a cheaper yuan, which gave Chinese exporters a competitive advantage. Treasury Secretary Steven Mnuchin said this month China’s moves to prop up the yuan helped American workers.
Having tighter control over the currency could allow for reform in other areas -- such as pursuing deleveraging at home with less concern about any impact on the currency, or even opening up domestic markets more to foreign participants, according to Ken Cheung, a Hong Kong-based currency strategist at Mizuho Bank Ltd.
It’s the latest twist on a long road for the yuan, which China fixed to the dollar from 1995 to 2005, thereafter allowing it to appreciate for a few years. Officials effectively re-instituted the peg during the global financial crisis in 2008, then again allowed it to start rising in late 2010. The currency retreated in 2015 and 2016 as capital outflows mounted.
“The Chinese commitment to market forces is rather tenuous,” said Russell Jones, a London-based partner at the Llewellyn Consulting research group. “In extremis, or really in any situation they are uncomfortable with, they are tempted to row back. There is an inherent distrust of markets that they struggle to set aside. Old habits die hard.”