China: G20 Postscript on Fed, RMB, and Credit Downgrades

Published on April 20, 2016

China’s Finance Minister Lou Jiwei and People’s Bank of China Governor Zhou Xiaochuan met their US counterparts, Treasury Secretary Jacob Lew and Federal Reserve Chair Janet Yellen, in Washington DC for the second G20 Finance Ministers and Central Bank Governors Meeting of 2016 on April 14-15 and at the 2016 spring meetings of the International Monetary Fund/ World Bank on April 15-17.

*** In discussions with their US counterparts, the Chinese officials communicated a message that the Chinese economy could manage a Fed rate hike trajectory of two hikes, for a total of 50 basis points, this year. Indeed they believe, whether based on a dialogue over the broader Federal Open Market Committee consensus of the Summary of Economic Projections rate “dot plot” or on other more extensive communications, that there is a very high chance the Fed will raise rates twice this year. ***

*** The Chinese officials came away from the meetings with the impression the US economic situation today is reasonably good, especially when compared with that of Europe and Japan. And given China’s economy is performing a bit better than expected, and assuming global financial markets continue to remain relatively stable if not positive, in other words assuming some continued greater comfort around some of those “global headwinds,” they expect the Fed will raise interest rates either in June or July. ***

*** Regarding the currency, Chinese officials expect the RMB could depreciate against the USD to a limited extent, to perhaps the 6.5500-6.6000 level, from the second half of June to July if the Fed were to follow through with its rate hike in that period. If China’s economic situation continues to remain stable in the second half of the year and the Fed follows through with a second hike, they expect the RMB against the USD could remain stable, ending the year between 6.5000 and 6.6000. ***

China’s Stabilizing Economy

The Chinese leaders were pleased to report back that when compared with the first G20 meeting in Shanghai just 40 days ago, the overall feedback at the Washington meetings was more positive on China’s economy, as global financial leaders gradually realize China’s economy has entered a “new normal” status, and were especially pleased to note that the IMF had upgraded its forecast for China’s economy even while lowering its forecast for global growth as well as for US growth in 2016.

The Chinese delegation stressed that the China Foreign Exchange Trade System’s RMB index enhances some flexibility of the RMB/USD bilateral exchange rate while maintaining stability around market expectations and keeping the RMB relatively stable against a basket of currencies. They believe both Treasury Secretary Lew and Federal Reserve Chair Yellen are concerned too strong a dollar could damage the US economy, and have expressed that in the longer term, over the next five years, the USD against RMB may actually have room to depreciate from current levels (see SGH 2/11/16, “China: A “Strong RMB” Strategy”).

Finance Minister Lou Jiwei and PBoC Governor Zhou Xiaochuan both noted at the meetings that there are increasing signs China’s economy is bottoming out. Despite ups and downs in market sentiment, they maintain the state’s economic resilience has always been underpinned by its strong fundamentals, and reiterated that China will maintain the continuity and consistency of its fiscal and monetary policies, and continue to strengthen supply side reforms in order to strike a better balance between economic growth, structural adjustments, and risk management.

On the sidelines of the BRICS finance ministers meeting, the Chinese delegation reiterated that China’s economy is taking solid steps and heading in the right direction, with China’s future growth likely to follow an “L-shaped” trajectory in the long run with a focus on “quality rather than quantity” of growth.

For this year, as things stand Beijing expects GDP growth for Q2 2016 to come in at around 6.7-6.8%, and overall GDP for 2016 to maintain that modest drop to around the 6.7-6.8% level from 2015’s 6.9% growth rate. Perhaps not surprisingly, officials see less room or need to cut interest rates this year, and rule out a lowering of the RRR rate, at least in this month.

On the SDR and Credit Downgrades

The public comments and headlines after the G20 meeting were dominated by politically interesting, even if rather bland, calls by both Zhou and Lou on IMF member states, especially G20 states, to start gradually broadening the use of the SDR, including in its use as a reporting currency in parallel with the USD, and to explore the issuance of SDR-denominated assets.

Beijing believes the SDR has the potential to resolve “existing deficiencies” in the International Monetary System, and the PBoC has started to release FX reserves data denominated in SDRs in addition to the USD already this month. The PBoC will also from what we understand explore issuing SDR-denominated bonds in the domestic market, most probably in July at the earliest.

Officials note that broadening the use of the SDR is one part of China’s (long-term) strategy to strengthen the RMB. They note greater use of the SDR will not damage the USD’s status as a reserve currency perhaps for the next ten years. But they also confide that they expect a broadening use of the SDR as well as a broadening use of the RMB may weaken the USD’s dominant reserve status in the world after ten years.

About three out of four of the G20 member states agreed with China on broadening the use of the SDR in the future. Apart from any political considerations, they believe that the SDR would help reduce valuation changes caused by frequent and volatile fluctuations of major currencies.

Chinese officials however do not believe Treasury Secretary Lew or Federal Reserve Chair Yellen were particularly enthusiastic or interested in their suggestions. Both Lew and Yellen nevertheless did agree to allow the G20 Communiqué to state “we support the examination of possible broader use of SDR.”

Chinese officials for their part appear to have demonstrated some sensitivity to having had to repeatedly address concerns to their global counterparts over China’s debt burden.

They pointedly, and rather defensively, maintain that in comparison to the US government debt, which just exceeded $19 trillion — meaning more than $58,000 for each American person — China’s per capita government debt burden is nothing to worry about.

Indeed, in a stern reaction against the string of credit rating downgrades by Moody’s Investors Service and Standard & Poor’s Ratings Services just prior to the G20 meetings, the Central Bank Governor and Finance Minister both vociferously stressed that China’s government debt is not particularly severe, that China will not have a debt crisis, China will not have a financial crisis, and China will not experience a hard landing

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