China May Let Its Currency Drift, But It Is Not About To Fight A Currency War

THE STATE COUNCIL last week proposed some measures that suggest to some that China is ready to indulge in bald-faced competitive devaluation to boost exports and thus growth—even if it did not cast it in those terms.

The Council said that the People’s Bank of China should widen the daily band within which the renminbi can trade on foreign exchange markets. This Bystander recalls that the last time the State Council weighed in on the subject in public, in March last year, within a fortnight the central bank had expanded the permitted trading range to 2% either side of the mid-point it sets from 1%.

If history is prologue, that will open the way to a devaluation of the currency that authorities might be happy to encourage, manage or manipulate — you choose your description. That would represent an escalation from the general monetary easing policies the central bank has been following for many months.

That, at least, is one argument that is being made. However, the opportunity to devalue the currency and the will do so are not one in the same.

Furthermore, even those forecasting a devaluation have to answer two essential questions. First, how sharp would any devaluation be? Second, would it be sufficiently large to encourage retaliation particularly from regional trading partners — though some Chinese exporters may feel that Japan, in particular, has already got its retaliation in first having seen a 30% devaluation of the yen in the era of Abenomics?

However, exporters are not the ones making the decisions, and, arguably, their domestic political clout over such decisions is at its lowest ebb in many a year.

The policymakers who will be making the decisions about the currency know that boosting exports to goose growth is just as old-school a stimulus as infrastructure investment spending and undertaken to the detriment of rebalancing. That remains the greater policy priority.

China’s foreign-exchange regime has its part to play in that. It may not be a leading role, but equally it is not a solo performer.

For that reason alone, we expect any devaluation brought about by a widening of the renminbi’s trading band to be slight, more a downward drift than a devaluation. Moreover, any sharp weakening of renminbi could trigger capital flight at a time when the financial system is not in the best of shape to weather it.

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China’s Policymakers Deliver GDP Growth Firmly On Track

CHINA’S STOCK MARKET is sufficiently divorced from the real economy for its recent turmoil not to have deflected growth from its gradually decelerating glide path. The second-quarter GDP figure has come in at 7% year-on-year, unchanged from the first quarter.

That is squarely in line with the official full-year target of growth slowing to ‘about 7%’ from 2014’s 7.4%. Policymakers will feel that measures introduced since late last year to prevent the slowdown becoming too rapid are taking effect and that the economy though still sluggish — if 7% growth can be considered sluggish — is stabilising.

Property prices in the biggest cities have ticked up as has industrial production, albeit selectively. The slowdown in export growth is moderating and that of imports, too.

However, there are plenty of inventories to be run down before import growth starts to pick up again. Low commodity prices will also keep the import bill low. The trade surplus that results in this circumstance will have given a fillip to the second-quarter GDP number. So, too, will the brokerage fees generated by the panic selling in the stock market. Combined, those factors would likely have been sufficient for the number to the magic 7%.

New bank lending is rising, thanks to four interest rate cuts since Novermber, looser reserve ratio requirements, and some policy direction. However, loose monetary policy is doing no more than steadying the economy.

That, in itself, is not a bad thing; the policy objective is a managed slowdown to a sustainable long-term growth rate. It is certainly better than a renewed ‘sugar-high’ of investment in infrastructure of dubious necessity and even less certain economic return.

The question remains of how quickly China can rebalance the economy towards greater domestic consumption-driven expansion and away from its dependence on infrastructure spending and exports for growth.

Consumption is holding up, but little more. Progress on economic reforms is moving slowly, though the anti-corruption campaign is starting to take aim at more and more vested industrial interests that stand in the way on that front.

Labour-market reform no longer appears to be the priority it was last year. The leadership remains concerned that an economic slowdown that brought unemployment could spill over into the much-feared social instability.

There is, however, no sign of industrial unrest on the scale seen in the 1990s’ slump, even if job security in some areas of the economy has become precarious. The announcement of the quarterly GDP figure made a point of noting that employment is steady.

The stock market crash will apply another brake to rebalancing, in particularly on financial-markets reform, notably interest rate liberalisation. It is, however, unlikely to be a permanent one. In the near term, fiscal and monetary easing is likely to continue to sustain the stabilisation.

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The Big China Market Crash In Little Stocks

A 30% DECLINE in the Shanghai bourse’s Composite Index? Pish! The Chinese market that has taken the heavy pounding is the over-the-counter National Equities Exchange and Quotations (NEEQ).

The Beijing-based ‘third board’ soared higher and fell further than its senior brethren in Shanghai. Prices of NEEQ-listed companies more than doubled between early February and early April before giving up four-fifths of that gain by early this month.

NEEQ was launched as a trial in 2006 to provide a way for tech start-ups in science parks to gain access to a source of finance that wasn’t state-owned banks. Its remit was gradually broadened. At the end of 2013, the market was opened to any innovative company from any of the seven designated strategic sectors that it is hoped will tilt the next phase of China’s economy towards domestic consumption, such as healthcare, media and tourism.

Ease of listing has attracted more than 2,500 companies. Last year, initial offerings raised 13.2 billion yuan ($2.1 billion) of capital for such businesses.

As with the first and second (Shenzhen’s Nasdaq-like ChiNext) boards, investment money, including from new mutual funds, poured in the early part of the year, pushing valuations way out of line with fundamentals. That was only exacerbated by the relative thinness of trading. The Shanghai exchange turns over — or at least was turning over — 10 times the trade in a day as NEEQ is likely to do in a year.

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Shanghai Stocks: A Kiss Is Just A Kiss

THIS BYSTANDER IS is reminded that on March 27th, 1929, the National City Bank said it would make the then huge sum of $25 million available to investors to buy stocks to brake a mini-crash on Wall Street. It worked — for a while. We all know what happened the following October.

If there is a thread of optimism to be drawn from the news that 21 brokerages are to set up a 120 billion yuan ($19.3 billion) fund to stabilize the plunging Shanghai stock market and that the central bank stands ready to rally to the cause, too, it is that authorities worldwide have had so much practice since 1929 in using non-market measures to prop up crashing stock markets they should be getting half-way decent at it by now. (Are there any financial markets that actually work on market principles left anywhere these days?)

But regulators, investors and market practitioners alike would also do well to recall the words Dooley Wilson sang in the classic film Casablanca:

You must remember this
A kiss is just a kiss, a sigh is just a sigh
The fundamental things apply
As time goes by.

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Making The Half Empty Glass of Financial Reform Go Away

THAT CHINA’S FINANCIAL system is “unbalanced, repressed, costly to maintain and potentially unstable” will not brook many arguments among policymakers in Beijing. It is, after all, why they are deep into an extensive programme of financial reforms, reforms that are seen as central to the long-term rebalancing of the economy.

It is also why “a weakly regulated shadow banking system” and a tendency of “wasteful investment and over-indebtedness” that is the consequence of a “traditional investment-driven growth model shaped by heavy state intervention” are also being tackled as policy priorities.

However, it is one thing for officials to know that and quite another to have it told to them publicly by the World Bank.

The phrases quoted above were all contained in a section of the Bank’s latest China Economic Update, published mid-week, which called for a quickening of financial-sector reform. The entire section has now been removed from the update, because, the Bank says, “it had not gone through the World Bank’s usual internal review and clearance procedures.”

Whatever, this Bystander is tempted to say. Any red faces at the Bank are probably due as much to the tongue lashing that would have come from Beijing as from the embarrassment of having to redact a section of a report post-publication.

With share prices on the Shanghai exchange in meltdown and the signing ceremony earlier this week setting up the Asian Infrastructure Investment Bank (AIIB), a putative rival to the Bank’s regional clone, the Asian Development Bank, and longer term to the Bretton Woods’ multilateral institutions as a whole, there could be some understandable sensitivity on both sides. Also, China readily takes public offense at any perceived criticism by any institution seen to be in the pockets of the U.S. and the EU — and the World Bank has previous in this regard.

What, to our mind, lies behind this particular spat is that when the International Monetary Fund comes to consider in October whether to endorse the renminbi as an official reserve currency by including it alongside the dollar, sterling, euro and yen in the basket of currencies that comprise its Special Drawing Rights, progress on China’s financial reform — and particularly whether renminbi interest rates are market-based — will be a key criterion.

The IMF reviews the components of its SDRs every five years. It would be an unwelcoming rebuff for China, which is being ever more assertive in claiming its place at international top tables, if it were made to wait until 2020 for inclusion.

As recently as March, Prime Minister Li Keqiang told Christine Lagarde, the IMF’s managing director, that China intended to speed up the financial sector reforms needed to meet the stringent requirements of stability and liquidity demanded of a reserve currency.  With IMF staff preparing their internal assessments for the 2015 SDR review around now, this is not a time when Beijing will brook any public plain-speaking about the pace of financial reform.

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China’s New National Security Law Emits An Icy Blast

CHINA HAS PASSED a National Security Law that sweeps a broad range of economic, political and social activities within its remit. The new legislation is far more all-encompassing than the counter-espionage law that it replaces. Pretty much anything Beijing wants to consider as a matter of national security it now has the legal footing to do so.

That can include ideology and culture, energy security, economic development, information, financial stability and just about everything in between. Civil rights campaigners have expressed disquiet about China’s growing crackdown on activism and dissent. Those concerns are only likely to be amplified by forthcoming counterterrorism and foreign NGOs legislation.

However, the greatest impact of the new law could be felt by companies. It requires that internet and information systems must be “secure and controllable” by the government. That makes foreign financial firms and IT companies extremely uncomfortable, but all foreign firms should be uneasy.

Much will depend on how discriminating China chooses to be in implementing the new National Security Law. Many ministries and agencies can make use of it to pursue policy objectives, including the promotion of domestic national champions. Some parts of government may use the new law aggressively, others sparingly.

The selectiveness of application can give foreign companies the impression that they risk having the law brought down on them seemingly randomly. That, in itself, will have a chilling effect.

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Drought Diplomacy In North Korea

North Korean leader Kim Jong Un visits Farm No. 1116, under KPA (Korean People's Army) Unit 810, in this undated file photo released by North Korea's Korean Central News Agency (KCNA) in Pyongyang on June 1, 2015. KCNA

CORN AS HIGH as Kim Jong Un’s thigh. That, at least, is what the picture above released by North Korea state media on June 1 shows.

The reality is likely to be different.

The isolated regime is suffering its worst drought in a century — probably its fourth ‘worse drought in a century’ of the past decade. Pyongyang’s news agency, KCNA, reported last week that paddies in the main rice-farming provinces of Hwanghae and Phyongan were drying up for lack of rain. Food supplies, never plentiful, are now at risk of falling — again — to the level of famine.

The devastation wreaked on the economy by the drought s compounded by the fact that 50% of the country’s electricity is generated by hydropower. Reports finding their way to this Bystander suggest that most parts of the economy are already feeling the effect of power shortages.

North Korea was hit by severe and fatal famine in the 1990s and relied on international food aid to get through. However, Pyongyang’s suspicion of humanitarian workers and reluctance to allow independent monitoring of food distribution, makes international agencies reluctant donors.

Relations between Beijing and Pyongyang are arguable at their lowest ebb. China even rebuffed North Korea’s putative interest in joining the Asian Infrastructure Investment Bank. Nonetheless, China’s foreign ministry said last week that the country was willing to help its drought-stricken erstwhile ally avoid a humanitarian disaster.

One set of questions is what price, if any, Beijing can extract from Pyongyang in return over its controversial nuclear program, and whether Pyongyang is ready to grasp an excuse providently offered to it by nature as an opportunity to back down from the nuclear tests and missile launches that have brought international sanctions down on it.

Another is whether Pyongyang can get food aid from Russia or Cuba, both places recently visited by senior North Korean officials, as an alternative to China, and even whether the regime is over-egging the pudding in regard to the severity of the drought. Last year, according to North Korea’s news agency, food production increased by 48,700 tons compared to 2013 — regardless of reports of severe drought.

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