China Research

Chinese mini devaluations in the past few days have caused a lot of reactions on global financial markets. I don’t regard these steps as particularly dramatic – particularly not after all developments during the past year or so.

1. We have known for quite a while that China has been affected by weakening exports. And at the same time the U.S. dollar has been strengthening – a currency the Chinese renminbi (or yuan) has been and still is closely linked to (without knowing the official weights of the Chinese currency peg).

2. We have known – and seen by action – for quite a while that China wants to give its currency more weight on international markets (see my blog www.chinaresearch.se). For this reason, it is easy to understand that China wants to have some more market aspects for its future currency fixing.

3. We also know that China has launched the view on more market-oriented fx rates already a couple of times before. Let’s wait and see to what extent Chinese authorities will stick to this old and new view in the future.

4. We also know that China wants its currency to be included in the composition of the SDR by the end of this year (which I questioned as an urgent step in a previous China blog). However, this calls for more market orientation.

5. We also know – or should know – that strategic exchange rate policy decisions are made by the small group (7 people) of the Standing Committee of the Politburo, not by the People’s Bank of China (PBoC). This is China’s most important political decision forum. The recent devaluations probably have a strategic and political character determined by the Standing Committee. This assumption should underline the relevance of the devaluation steps.

6. We should know – or at least learn by now – that the recent days have shown that China’s future financial deregulation steps will become increasingly difficult the more the currency and the capital account will be deregulated. I have written quite a lot of lines on this issue in the past years. Some of them you can find in my China blog at Linnaeus University chinaresearch.se

7. We should know and understand that economic analysis of China is very difficult. Newcomers may feel this is not the case. But it is! I am quite sure that future challenges – may be a couple of years from now – will be much larger than the current one. More on this can be read in my article “Otillräcklig analys av Kina” in Dagens Industri from July 31.

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

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Abstract

Economists – particularly foreign financial analysts, also in Europe – focus mainly on the Purchasing Manager Indices (PMIs) and quarterly GDP changes when analyzing Chinese growth. This is understandable since these data are easily available. More recently these data did not produce an optimistic picture for China’s economy. But does this information really provide reliable information on China’s growth performance and outlook? Does this analytical approach capture the strategy and policy changes announced during the Third Plenum in November 2013?

Certainly not. Consequently, foreign and even domestic investors run the risk that portfolio and particularly more long-term investments are too heavily based on short-term indicators that do not reflect ongoing structural improvement measures or policy changes.

The paper will summarize past and current discussion on Chinese GDP data and deal with the alternatives for assessing economic growth and its quality. Merely relying on an improved and widened analysis of Chinese reform policy since November 2013 is difficult and has its limits. But better analysis can be created by economists themselves even under current conditions. Transparency is still by far too poor. Improvements should not be that difficult to achieve all the same. Some ideas are given in this paper – and also hints how and where to find information on structural improvements that have taken place or are planned concretely for the nearer future.

Better insight into Chinese reform policy and underlying GDP-growth conditions could give a sounder input for decision-making by domestic, European and global investors, Swedish and German companies included. The ambition of the paper is to contribute to a move from too much short-term to more medium- and long-term analysis of China’s development – an approach that should be promising also from a European corporate perspective.

JEL:   E60, F23, F 60, O53, P21, P48.

Read the full article here,
China’s Strive for Quality of Growth and Growth Data.pdf

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

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Chinese statements and domestic debate make increasingly clear that China soon wants to become part of the International Monetary Fund’s (IMF’s) artificial currency, the so-called Special Drawing Rights (SDRs) – also described as kind of reserve currency for the IMF-member countries. Currently, one SDR contains fixed amounts of four currencies denominated in USD, i.e. somewhat above 40 percent for the USD and slightly below 40 percent for the EUR plus around 10 percent for both the GBP and the JPY.

In January 2016, the Chinese want their renminbi (RMB) to become the fifth currency in the SDR basket. The question, however, is whether China already is mature for such a big step. To get there, some main criteria for SDR entry have to be met:

– the size of the country’s exports;

– the currencies included in SDRs should be “widely used” and “widely traded”

The first criterion, of course, would be easily met by China, the no 1 exporting country in the world.

The evaluation of the second criterion with its two parts, however, is much more complicated. One must certainly note the RMB today is widely – and increasingly – used when it comes to international trade finance. Chinese RMB or yuan have also a growing weight in the composition of currency reserves in an increasing number of central banks.

Consequently, the possible membership of the RMB in the SDR composition will probably be decided by the interpretation of the question whether the Chinese currency is “widely traded” – which in my view should be related to free forex trading of all over the world. This is currently not the case. The IMF is talking more precisely about “widely traded in the principal exchange markets” which, however, opens for broad interpretations. As the IMF expressed the issue very recently: the future inclusion of the RMB in the SDR is not a matter of “if” – but of “when”.

Altogether, I feel strongly that joining the SDR by the RMB already in January 2016 would be premature. I share the view that China will be there at some point in the future. Reforms of the domestic financial system and the gradual deregulation of the capital balance seem to be much more important than the RMB’s joining of the SDR already in a couple of months – and not to forget the need of much better transparency. But we know that the Executive Board has the mandate to change the entry criteria, by, for example, giving emerging markets more influence in IMF decisions.

Hopefully, the decision by the Executive Board of the IMF will be based purely on economic, financial and institutional criteria – and not on political considerations. Nota bene: This is no opinion against emerging markets per se which I indeed have sympathized with since many years ago.

Sources:                                                                              http://www.imf.org/external/np/pp/eng/2011/092311.pdf   http://www.imf.org/external/np/exr/facts/sdr.htm

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

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