China’s new pledge to depeg its currency from the U.S. dollar underscores a difficult fact for Beijing: the U.S. Federal Reserve could blunt its efforts to rekindle Chinese growth.The Fed is widely expected to raise rates this week amid signs of a strengthening U.S. economy. Meanwhile, China’s economy is going the other direction, with Beijing cutting interest rates and making other moves to loosen monetary policy and spur slowing economic growth.
A U.S. rate increase could hinder that effort. It would likely make the dollar stronger, forcing China to intervene in currency markets to maintain the peg. That means buying yuan, often from Chinese banks, which effectively takes money out of China’s financial system at a time when Beijing is trying to make more available to its businesses and consumers.Already, credit remains tight for many Chinese borrowers, especially small and private companies, despite six interest-rate cuts and looser bank-reserve requirements enacted over the past 13 months.
On December 11, 2015, China’s central bank signaled its hope to break up that dynamic by pegging the yuan to a basket of currencies — including the dollar, euro, yen and 10 other currencies — instead of the U.S. dollar alone. That would give the yuan room to fall against the dollar…
But the move has also set off selling of the yuan both within China and in what is known as Hong Kong’s offshore market amid investor expectations that a currency basket means a weaker yuan…In a bid to calm the jittery markets, the PBOC said in an editorial posted on its website on December 14, 2015 that China’s still-high growth rate, ample foreign-exchange reserves and rising foreign demand for Chinese assets should work together to keep the Chinese currency at a reasonable equilibrium.
It is far from clear that China will depeg its currency from the dollar — something it has said it would do in the past only to retreat. Decoupling risks a loss of investor confidence in the yuan’s stability, which could lead to more money leaving China, according to Chinese officials and advisers to the central bank.
“Abandoning the peg would be an important step toward achieving monetary-policy independence, but destabilizing capital outflows could hold the central bank back from doing that,” one of the advisers said. In early 2009, four years after it said it would divorce the yuan from the dollar, China hitched the value of its currency to the greenback again to keep the yuan from falling in the midst of the global financial crisis.
The peg has “complicated domestic macroeconomic policy management as economic prospects between the U.S. and China have diverged,” said Eswar Prasad, a Cornell University professor and former China head of the International Monetary Fund.
Some economists blame the yuan’s strength for some of the problems. They say an overvalued yuan relative to its purchasing power has led Chinese companies to cut prices and lower wages to stay competitive. Also, China’s exports to countries like Japan and those in Europe in recent months have declined faster than its sales to the U.S.”The overvaluation of the renminbi is a root cause of China’s economic ills these days,” said chief economist Lu Zhengwei at Industrial Bank Co., a large national bank in China.
Excerpts from China’s Pledge to Divorce Yuan From Dollar Faces Fed Test, Dow Jones Business News, Dec. 14, 2015