FEBRUARY 24TH 2016
WILL CHINA DEVALUATE THE YUAN ONCE AGAIN?
China’s economy has been on a spiral. Restructuring the whole financial system has not been an easy task, and very brave steps have been needed from time to time. According to the Financial Times, China is facing a fundamental problem known as the ‘impossible trinity’. This concept was presented by Robert Mundell in the late 1960s, and it refers to the pursuit of incompatible objective. More specifically, it is impossible to seek simultaneously more than two variables between an independent monetary policy, a fixed exchange rate and free capital movements.
Soon enough, authorities in Beijing will have to prioritise further steps of their economic transition. The trade-off will confront strengthening the Chinese Yuan versus stabilising financial markets. Hence, if the leaders insist with capital liberalisation, they will have to allow the currency to fall drastically or float freely.
Zhou Xiaochuan, governor of the People’s Bank of China (the country’s central bank), seems optimist about their possibilities to overcome this conundrum. In his opinion, there is no basis for devaluation, as the country’s reserves are adequate. Moreover, China does not need tighter capital controls.
According to Forbes, rescuing the currency should be the priority. The Chinese Yuan have faltered in recent times as Chinese people and businesses move their capital abroad in search for financial stability. In order to control this outbound flow, Beijing has re-imposed capital controls and intervened currency markets to support the Chinese Yuan.
At the micro level, banks are giving-out more credits to stimulate the real economy. People and manufacturing companies are increasing their debt, and the result are yet to be seen. Nevertheless, at the moment, the central bank is injecting more cash into the banks, decreasing currency value due to increasing emission.
At the macro level, the People’s Bank of China is using currency exchange out of their reserves to counterbalance the decreasing tendency of the Yuan. The result is a fall of US$512.7 billion out of the country’s reserves during 2015, and another US$99.5 billion just in January 2016, according to the State Administration of Foreign Exchange.
Uncertainty is the name of the game in today’s economy. China is no exception in a global tendency of structural crisis. It is utterly important to follow closely how the Asian country deals with this challenge. Beijing’s unique social and political system might come in handy sailing out of the storm. In any case, the ride will be anything but smooth.
Sources:
http://www.cnbc.com/2016/02/23/capital-controls-in-china-a-possibility-expert.html
http://www.ft.com/intl/cms/s/0/72861246-d975-11e5-a72f-1e7744c66818.html#axzz416pZ41l3
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Image: USNews.com
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