China Research

China finally made it. The International Monetary Fund (IMF) has now met China’s strong desire to get its currency – the renminbi (RMB) – accepted as the fifth currency of the IMF’s artificial currency basket by the name of Special Drawing Rights (SDR). Until now, SDRs contain only the U.S.dollar, the euro, the yen and the Pound Sterling.

Understandably, the Chinese are celebrating this event. Current Chinese enthusiasm reminds strongly of China’s entry into WTO exactly 14 years ago. International or global recognition is something Chinese politicians really appreciate. One should also add that China’s WTO entry – purely economically – most certainly was a much more important event than now becoming part of the SDR basket.

For this reason, it is not quite easy to understand the strongly praising words by Christine Lagarde, the head of the IMF. Lagarde said among other comments that “the decision to include the RMB in the SDR basket is an important milestone in the integration of the Chinese economy in the global financial system”. She adds officially that “it is also a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems.”

I have my doubts about the prestigious way of presenting the RMB inclusion in the SDR by the IMF. Why is there so much noise about this step from both the IMF, Western players on financial markets and journalists? The laudation may be justified later on retrospectively – but not under current conditions. Five questions or arguments make me skeptical.

First, SDRs have currently not really an important function as an international reserve asset. Their market share is only a few percent (read more on this by Maurice Obstfeld, “The SDR as an International Reserve Asset – What Future?”, International Growth Centre, LSE, March 2011). Could it be the case that the IMF via the RMB entry now starts working for an active revival of this almost forgotten IMF tool? Something to remember: private institutions do not hold or use SDRs.

Second, has the RMB inclusion mainly happened for political – and not for economic – reasons?

Third, the presented glamour around the IMF decision puts too much emphasis on China’s international financial relations whereas the need of further domestic financial reforms currently is much higher and more urgent – despite a number of improvements at home more recently, particularly when it comes to the processes of setting interest rates.

Fourth, how substantial are the accomplished improvements of the financial system – which Lagarde so strongly pointed at during the press conference – in Chinese reality? How much are they worth in relation to all the potential Chinese bad loans of the official and the shadow banking sector that we have so little information about? What about the real size of the local government debt? What about bubbles in the housing market and local industry parks? And where are the improvements in Chinese transparency that Lagarde has been talking about during the press conference? I haven’t found very much myself, particularly not in the statistics that are analytically important to China and the rest of the world.

Fifth, it can be discussed whether RMB really had met the second criterion for joining the SDR which demands that the currency is “freely usable”. I could not find any clear definition of what is called “freely usable” in this specific Chinese context. Did I miss something?

Initially, i.e. from October 2016 onward, the RMB is given 10.92 % in the revised SDR basket. The U.S. dollar received 41.73 % (before 41.90 %), the euro 30.93 % (before 37.40 %), the yen 8.33 % (before 9.40 %) and the British pound 8.09 % (before 11.30 %). China’s new share seems to be relatively high, compared to both the euro, the yen and the British pound. And why did the euro and the pound lose that much ground whereas the U.S.dollar remained roughly unchanged? Sure, I know there is a revised formula for the share calculations. But how scientifically and statistically strong are the criteria of the components of the new formula? The information given by the IMF, however, still keeps a number of answers quite open. More research on this issue could be interesting (which I may deal with myself).

I know from unofficial sources that the ECB has been very irritated about the considerably decreasing weight of the euro in the revised SDR basket. Information to the ECB about the forthcoming downgrading of the euro in the SDR system did obviously not work very well – an issue that the IMF probably could have handled more smoothly.

To avoid misunderstandings, nobody can blame China for having tried and succeeded. That’s not the point. The point is the insufficient transparency of the IMF in certain parts of the decision process. What about the theory that the IMF – by sticking strongly to this recognition of China – mainly intended to encourage China to speed up and/or intensify further economic and financial reforms?

Anyway, for the time being, financial improvements and reforms of the domestic financial system will be much more important to China’s future than ambitiously deregulating the cross-border capital balance. Hereby, the issue of sequencing should not be forgotten – i.e. implementing the reforms in the right order (look here, for example at the works of S. Edwards and P-R Agénor).

Still valid also for China: stability begins at home!

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

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During the last fifteen years, Chinese crude steel production increased eightfold. But in 2015 the Chinese crude steel production will show a slight decline of around 2 per cent. Main reasons are less infrastructure investments and a lower demand from the construction sector. We estimate the overcapacities of the Chinese steel industry over the domestic demand of more than 250 million tons per year. As a result the Chinese exports of rolled steel products (flat and long) will climb up. During 2014, the total Chinese exports equaled around 93 million tons. For 2015 we expect a rise to around 135 million tons: nearly 9 million tons will go into the countries of the European Union while more than 50 per cent of the exports will be delivered directly to the Asian neighbor countries, another 10 per cent to the Gulf region and around a sixth to the Americas.

An important question is why China could sell its steel products on such a low-price level. First, prices for the raw materials iron ore, coking coal and steel scrap declined during the last year. As a result the producer costs came down. Second, the depreciation of the renminbi cheapened the Chinese steel exports beginning from the third quarter 2015 onward. But does it make sense to export even in case that 11 from 15 of the leading Chinese steel producing companies generate losses during the first half of 2015? In our view, the number of Chinese loss producing companies will increase in the second half of 2015. An important point is that in some provinces the steel exporting companies get subsidies for exports which compensate them partly or fully for their losses.

But will China now reduce its crude steel production or hold it on such a high level even in the future? We expect that China will stabilize the steel production on the current level and ramp up its exports even with losses for the steel producers. But what is the reason behind this on a first appearance economically abstruse behavior? In our point of view, there exists a political and a social misdemeanor behind the export and production activities of the Chinese steel producers. They often do not act independently from the political management in China.

The Chinese steel producing companies belong to the leading employers in many provinces. Even when they are privately or in majority privately owned, the province governments delegate a high responsibility for full employment in the region to them. If they are state-owned, there exist sometimes directives for high-employment levels. The provincial government by itself has an own interest in high employment levels in the region.

On the one hand, full employment or nearly full employment generates high income in the region and result in higher standards of living. In the internal ranking with other province politicians, the “helpful” province government improves its relative position and this enables them for further career leaps. If the people in a region are employed and have a higher standard of living, this will normally result in political calmness and social harmony in this part of the country. And the political calmness and social harmony secures the political survival of the provincial political leaders. On the other hand, if a province is politically instable because of unemployment, population movements and social unrests, the political careers of the members of the province government will end very quickly.

But currently the Chinese steel industry behaves very cautiously and helps to secure social harmony and economic stability. The overcapacities in the steel production lead to further rising exports which means that the Chinese problems with the huge volumes of steel production will be exported to other countries. We expect therefore that anti-dumping measures will be the answer to this Chinese behavior by both NAFTA the European Union.

Dr. Heinz-Jürgen Büchner
Managing Director Industrials, Automotive & Services
IKB Deutsche Industriebank AG, Frankfurt

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In a few days, the United Nations’ Climate Change Conference is scheduled to start. Particularly three developments are encouraging since the failure in Copenhagen six years ago. First, there seems to be more global co-operation on this important issue. Second, this improved global understanding seems to include jointly China and the U.S. Third, China has discovered the limits of very rapid economic growth, either voluntarily or involuntarily by enormous air and water destruction in the world’s largest country (by population). The (quite) new Chinese popular awareness of the environment is certainly encouraging and cannot be neglected by politicians anymore.

In Hong Kong’s South Chinese Morning Post, I could read in the beginning of this month about horrible pollution problems in northeastern China with noted record pollution. Many other concrete examples of this kind certainly exist as well. Altogether, China as the number one global CO₂ producer has certainly a special responsibility to make the fight against global pollution more effective (without forgetting India). Improved co-operation with the U.S. on this issue would most certainly be beneficial for both China itself and the whole globe.

Before, China – even as the number one global CO₂ polluter – gave the U.S. the main responsibility for CO₂ pollution and global warming, explained by the lower population in the U.S. or its highest pollution per capita. Since pollution really has become a global phenomenon, such a distinction does not make sense anymore. This is why the whole world is waiting for good Sino-American co-operation on all environmental issues.

In this context, it should be singled out that carbon energy production – and not car pollution – widely is regarded is regarded as the most terrifying threat to a better environment in China (without neglecting car pollution). China has to act strongly in both of these two decisive fields, by domestic developments and by co-operation and business with western firms.

Consequently, there still exist many commercial opportunities for many western firms – Swedish companies included – with the big country of China, despite weakening growth prospects compared to the past decade.

However, there still is a catch. Sure, China seems to be committed to its environmental goals, for example peaking CO₂ pollution by the year 2030. But on which GDP and/or industrial production levels will this peak be reached? So far, I haven’t observed any numerical details on this important detail. At least I would like to see, two or three growth scenarios and their assumed effects on the environment.

Unless more measurable changes are planned, my doubts about major future effectiveness of environmental improvements will stay in place. I do hope they will come. Shouldn’t the environment be a good area for improved Chinese transparency?

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

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