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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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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
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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 ,