THE RECENT VOLATILITY in financial markets has brought into question the capacity and nerve of China’s policymakers when confronted with variables they cannot control politically. This heightens concern not so much about the gathering pace of the economic slowdown as about the country’s prospects for the next stage of the economy’s d development, ‘rebalancing’ away from export and capital investment-driven growth and towards domestic consumption.
In what was mostly a closed economy, policymakers had relatively few monetary and fiscal levers to pull, but they were effective when yanked. Administrative guidance was particularly efficient. As the financial system has been opened up, the less guidable animal spirits of market forces have come more destabilisingly into play. The new tools to control them have arrived piecemeal, an inevitable consequence of the deliberately measured pace of financial-sector liberalization.
The currency has been in the vanguard of the reforms in lockstep with freer capital flows, moving steadily along the path of full convertibility, whose final destination has allowed the yuan to achieve the accolade of inclusion in the International Monetary Fund’s basket of reserve currencies.
The People’s Bank of China has a deserved reputation in financial circles around the world for the high calibre of its officials. But even their competency has been questioned following their uneasy and unexpected guided devaluation of recent weeks and their attempts to bring the tightly managed onshore and market-driven offshore exchange rates into alignment, a move undertaken for SDR-related reasons as much as currency management, but done with a tin ear for timing.
The central bank’s switch to managing the yuan’s value against a basket of currencies was both poorly signaled and sent mixed signals to investors, who tend to focus on the exchange rate against the dollar. If investors lose confidence in the central bank’s effectiveness in the execution of monetary policy, it will only feed the volatility of the equity markets, where officials have already revealed a far from sure touch in their attempts to stabilize the markets.
While it may be virgin territory for many of them, policymakers clearly miscalculated the linkage between tumbling equity prices and speculative pressure on the currency, and how quickly the currency would become the focal point of market unease about China’s economic prospects among investors. It also says something about how the world has changed that the competency of Chinese policymakers has supplanted U.S. monetary policy as the primary determinant of global investor sentiment.
It is the nature of financial markets to be volatile in greater or less degree. Policymakers will learn by experience the limits of their reach in such an environment. Three decades of history will have left them more naturally inclined to intervene than not, which will make that learning painful and slow — last summer’s lessons from the mishandling of the stock-market plunge were clearly not well learned this most recent time round.
However, the broader concern to this Bystander is that financial-market turbulence will encourage Beijing to backslide on further financial-sector reform and more broadly on rebalancing. For some months, it has been dialing back on talking up the need to reduce government intervention in the economy. The third Party plenum at which the top leadership pledged to give market competition a decisive role in the economy seems longer ago than the 30 months it was.
Similarly, the notions that powerful bureaucrats can be a panacea for all economic ills and that the state can trump the market are fading. With that will come doubts in the some senior minds that the Party can pull off the unprecedented trick of liberalizing China’s economy without doing the same to its political system, unacceptable to the Party though the later is.
The certainty that state control provides versus the benefits that free markets bring is the inherent contradiction that may have been manageable for the past 30 years of the economy’s modernization but which, as Japan and South Korea have shown on a smaller scale, becomes more not less contradictory as an economy advances and becomes too big and complex to answer to political imperatives — and to the bureaucrats imposing them.