https://asiatimes.com/2022/04/its-time-to-stop-betting-on-a-wimpy yuan.
It’s time to stop betting on a wimpy yuan
Rising inflation and strong exports point to continued tolerance in Beijing for a muscular currency
China’s latest inflation data offer something for everyone. Economists fretting runaway global costs are alarmed by the 8.3% jump in producer prices in March from a year earlier.
Those in the “inflation-risks-are-manageable” camp focus on the milder 1.5% rise in consumer prices.
The truth, as is often the case, lies somewhere in the middle. Yet the risks are increasingly skewed to the upside.
The March gain in the consumer price index marks an acceleration from the 0.9% increase in both of the previous two months. And the fallout from Russia’s Ukraine invasion is likely to exacerbate the risks that factory-gate inflation gets passed on to households.
So one thing is clear: traders can stop betting on a weaker yuan.
In recent weeks, the chatter was that global headwinds might push President Xi Jinping’s government to engineer a weaker exchange rate to support exports. But sharply higher costs of oil, gas, grain and other vital commodities validate Beijing’s decision to tolerate a strong yuan despite geopolitical chaos.
Even as the dollar soars against the Japanese yen, it’s down 3% versus the dollar over the last 12 months. The yuan’s gains might be far more pronounced if the US Federal Reserve and the People’s Bank of China weren’t taking interest rates in opposing directions.
In Washington, the Fed is embarked on what virtually every analyst agrees is a long, destabilizing and multi-step tightening process. With US inflation at 40-year highs and Russia pushing on with its war, the odds favor bigger CPI increases. A Bloomberg survey of economists has consumer prices rising 8.4% in March.
In Beijing, the PBOC has been easing monetary policy as Russia-driven headwinds hit global demand and fresh waves of Covid-19 infections have Xi’s government locking down Shanghai.
This has economists like Iris Pang at ING Bank predicting the PBOC will announce another cut in banks’ reserve requirement ratios for small and medium enterprises and also reduce benchmark rates as early as this month.
“We estimate that Shanghai will suffer a 6% GDP loss if the current [Covid] lockdowns persist in this month alone,” Pang says. “That’s a 2% GDP loss for the whole of China.”
Economist Ming Ming at CITIC Securities notes that “given the government’s firm objectives of stabilizing economic growth and boosting credit expansion, there will remain room for further monetary easing.”
The only question is the timing.
This aerial photo taken on June 22, 2021, shows cargo containers stacked at Yantian port in Shenzhen in China’s southern Guangdong province. Photo: AFPSolid fundamentals vs dark clouds
It helps that China’s export engine hasn’t sputtered so far this year. In the two-month period covering January and February, exports rose by double digits – 16.3% from a year ago to US$544.7 billion. Imports jumped 15.5% to $428.7 billion, a sign China is sharing its growth with its Asian neighbors.
Yet a darkening global scene is making this year’s 5.5% growth a tougher reach for Xi’s government. It means that, on the one hand, the PBOC and Xi’s Ministry of Finance are keen to cap the yuan’s gains for a time.
On the other, inflation trends mean a stronger exchange rate is coming in quite handy in taming overheating risks.
There’s an argument, too, that China’s 2020 experience might discourage PBOC Governor Yi Gang from taking more aggressive easing steps.
In hindsight, says economist Wei He at Gavekal Research, “it’s clear that China’s policy response to the 2020 lockdowns caused the property market to overheat.”
Although the PBOC tightened credit conditions rather early, driving interbank interest rates higher in May 2021, money growth continued to accelerate for several more months, reaching 13.6% in October 2021 from 10.3% in February.
“That rapid surge of credit, along with strong export growth and pent-up household savings, caused economic growth to bounce back quickly,” He says. “In particular, property sales surged to their highest growth rates in years and prices jumped to new highs.”
Then, Xi’s government spent much of 2021 working to cool a property boom, an effort that arguably overshot, with GDP growth falling below 5% in the second half of 2021.
“The experience of 2020, then, seems to argue for policy restraint this time around to avoid another boom-bust cycle,” He argues. “The supply-side constraints from lockdowns should be temporary, with activity bouncing back afterward.
“The main priority is to alleviate income losses during the lockdown, which the government is already working on. Indeed, there is no sign policymakers want to flood the economy with liquidity this year.”
At the PBOC’s last monetary-policy committee meeting on March 30, Yi’s team reiterated its priority of curbing leverage and restoring balance to growth in credit and nominal gross domestic product.
All this, economists say, suggests only a modest acceleration in credit growth of perhaps 10% to 11% by the end of the year.
Xi’s government, meantime, is likely to focus more on fiscal stimulus, using funds it stockpiled in January and February, rather than issuing fresh debt to boost spending.
In late March, the Communist Party’s State Council pledged it would “insist on the target and not relax” its 5.5% growth projections despite downside risks intensifying since 2021.
Nobody knows how long the lockdown in Shanghai will last. Photo: WikiCommonsHeadwinds from two directions
These challenges, however, collide with inflation risks limiting authorities’ ability to stimulate.
“Rising food and energy price inflation limits the space for the PBOC to cut interest rates, despite the rapidly worsening economy,” economists at Nomura Securities argue in a note to clients.
Above everything else, says analyst Jeffrey Halley at Oanda, “it is China’s Covid situation that is making Asia nervous.” Halley notes that “the weekend press was full of stories of locked down Shanghai residents unable to secure food supplies,” with cases rising to 27,000 on Sunday.
“Ominously,” Halley adds, the giant city of Guangzhou closed its schools until April 17.
“With China’s government doggedly sticking to its Covid-zero policy,” he says, “fears are increasing that an extended lockdown in China, which may spread to other major industrial cities, will darken an already cloudy outlook for China’s growth.”
Amid so many risks, another 6%-plus gain in the yuan in 2022 on top of last year’s advance could add pressure on exports. Yet neither is guiding the exchange rate lower this year – a palatable policy choice for short-term and short-term reasons.
The risk of importing inflation tops the list of short-term concerns. Topping the long-term list is squandering years of progress in building for the yuan – and creating a more vibrant innovation-based economy.
If devaluing your way into the ranks of the Group of Seven nations was a winning strategy, then Argentina and Venezuela would be world-beating economies. Far more developed Japan would be cranking out tech unicorns as steadily as Indonesia, instead of watching from the sidelines.
In mid-March, there were hints that the PBOC was working to cap the yuan with its currency fixings process. Indications were that “clearly the authorities are becoming increasingly uncomfortable with yuan strength at a time of slowing economic momentum,” notes strategist Mitul Kotecha at TD securities.
Yet, with inflation risks rising and exports holding up remarkably well, Xi’s government seems to be keeping its eye on the long-term prize: increasing trust in a yuan that’s fast gaining market share in global trade.
Follow William Pesek on Twitter: @WilliamPesek