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Our understanding after a week of meetings in Beijing with government officials is that a number of new regulations have been imposed
currency borrowings reached $ 1.2tn in Q3 last year, as chart 14 from the Wall Street Journal confirms. More than half of this debt is thought to be US dollardenominated.
Pressure is clearly building as the renminbi has fallen by 7 per cent since last March, and domestic interest rates have risen by more than a fifth since Q3. The problems are likely to prove complex to unwind, given that the government has reached the end of the road with its initial response, which was to use its forex reserves to support the renminbi and reduce interest rate pressure. Its reserves have now fallen by a quarter to $ 3tn since their June 2014 peak, and are approaching the $ 2.6tn level, thought to be the minimum needed for the economy’ s day-to-day operation.
Since the New Year, it has therefore adopted a new strategy of further restricting capital outflows and hiking short-term interest rates to deter currency speculators. This highlights that its key issue is now the age-old challenge of managing the so-called‘ Impossible Trinity’, which says it is impossible to maintain a stable exchange rate, free capital movements and an independent monetary policy at the same time.
Unfortunately for Beijing, this challenge is being intensified by Donald Trump’ s election victory, given his desire to label China a currency-manipulator – even though there is little evidence to support the accusation. Perception matters more than reality in today’ s febrile political environment and clearly the government felt obliged to defend the Rmb7:
▼ Chart 14
China’ s corporate borrowing is vulnerable to higher US interest rates
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1.5
1.0
0.5
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Source: The Wall Street Journal
$ 1 level ahead of Trump’ s inauguration. But the tools it is using, such as overnight interest rates of 60 %+ as seen early this month, cannot be maintained for long. History suggests they normally only defer the inevitable by further slowing the economy. As long-time China-watcher, Charlene Chu of Autonomous Research has noted:
“ China’ s authorities have chosen to pursue harsher measures against capital outflows over a large change in the exchange rate to address the country’ s outflow problem, at least for now. This could work for a few quarters, but we think closing the gates is not feasible
CHINA’ S OUTSTANDING EXTERNAL DEBITS
BUSINESS SECTOR
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over the long run for the largest trading nation in the world with a USD33tn banking sector. We expect growth to begin decelerating in 2Q17, as a weaker credit impulse passes through, but this is of secondary importance to outflows and the currency.”
Separately, Michael Pettis, finance professor at Beijing University has argued:
“ For now the PBOC has more than enough reserves to implement any currency strategy it chooses. It should avoid dissipating credibility by attempting to boost growth and reverse capital flight with a currency strategy( of devaluation) that cannot do either. It should focus on reining in debt. If capital outflows and slower growth are driven by uncertainty over debt,