China: G-20 Meeting, Volatility, Growth, and FX

Published on February 22, 2016

In the run-up to the two day G-20 Finance Ministers and Central Bank Governors meeting that opens this Friday in Shanghai, China’s President Xi Jinping and Premier Li Keqiang tasked the People’s Bank of China Governor Zhou Xiaochuan, Finance Minister Lou Jiwei, and other senior financial officials who will lead China’s delegation with two goals.

*** The first will be to reassure their counterparts from other major economies that they have little cause to worry about China’s economy, and that they should have little cause to worry about China’s management of its currency. ***

*** The second is the commitments they will seek from their G-20 counterparts, on two fronts: first, a pledge the G-20 countries cooperate to tackle global economic tensions and reduce the recent market volatility that has raised fears of currency wars and trade protectionism, and; second, that the G-20 countries agree to refrain from competitive devaluation of currencies — with China at the forefront on that latter pledge. ***

*** Chinese officials will also stress Beijing’s commitment to a series of “proactive” fiscal policies to ensure that Chinese GDP growth does not drop below 6.5% this year, including: one trillion yuan in tax cuts for State-Owned Enterprises (SOEs) in effect from November 2015 to March 2016; an additional 550 billion yuan in SOE commodity purchases, especially crude oil, agricultural products, gold and other major nonferrous metals from overseas that started in December 2015 and will continue until March 2016; an increase in the deficit to GDP ratio to 3% in 2016 from 2.3% in 2015, and; at least 400-500 billion yuan in tax cuts and financial subsidies for small and micro enterprises in 2016. ***

Growth and FX Promises and Initiatives

Chinese officials will deliver a message that as a responsible global power and the host country for the 2016 G-20 ministerial meeting, China will seek not just to stabilize its own economy, but to pursue policies that will fulfill its responsibility to promote regional and world economic development as well.

While conceding that China’s economy has been weakening, they will stress the basic underlying fundamentals have remained unchanged. Indeed the Chinese leadership expects that with broad supply-side reform, strong proactive fiscal policy, deeper urbanization, and more appropriate monetary policies, China will achieve its 2016 economic growth targets of above 6.5% as planned.

China, they stress, will continue to improve the formation mechanism of the RMB exchange rate and commit to maintaining the RMB’s stability against a basket of currencies, ensuring the basic stability of the exchange rate with “no foundation for constant devaluation.”

Chinese officials believe the Shanghai meeting will reiterate and reach an explicit agreement about the need to avoid competitive currency devaluation, and they stress that G-20 member nations should increase their “awareness of international coordination” even if this consensus “may not be observed in practice.”

On the Renminbi, they will repeat that there is no basis for sustained depreciation – and will continue to pledge not to allow speculative forces to dominate market sentiment.

Managing the RMB

Although speculators are heavily shorting China’s equity markets as well as the RMB, Chinese officials warn the PBoC has multiple ways of defending the currency, and in order to maintain relative stability of the exchange rate, they will refrain from cutting interest rates and will reduce the number of times they lower the Reserve Requirement Ration (RRR), relying instead largely on fiscal policy for stimulus (see also SGH 2/5/16, “China: Premier Comments on Economy and Policy”).

Indeed in a phone call earlier this month with US Treasury Secretary Jacob Lew, China’s Vice Premier Wang Yang explicitly pledged that China will refrain from competitive devaluations and will not weaken the RMB in order to boost its exports.

In return Wang urged the US to keep the dollar in an “appropriate range,” and urged the Federal Reserve to manage its monetary policy tightening path “very carefully.”

Beijing nevertheless reserves the right to allow the RMB to gradually weaken if the economic fundamentals dictate, and the PBoC will deliberately continue to allow the currency to fluctuate more freely in the markets as time goes on.

But officials stress again the fundamentals of China’s economy do not support a further sharp depreciation against the USD.

And in the big picture, far from seeking – or succumbing to – a one-off devaluation as many speculators assume, they point to the long-term “strong RMB strategy” that shows a clear picture of the RMB against the USD in a secular uptrend for the next fifteen years – a strong RMB that will accompany the country’s path to becoming a major economic power (see SGH 2/11/16, “China: A “Strong RMB” Strategy”).

For this year, Chinese officials believe the RMB against the USD could vary on either side of 6.5000 and 6.6000 on the spot market if China’s GDP reaches 6.7-6.8% as planned – and if the US Federal Reserve were to raise interest rates no more than once or twice in 2016.

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