The visit to the US later this month by China’s President Xi Jinping comes at a politically sensitive time, with volatility in China’s markets—widely attributed to the effect of policy decisions—rippling globally. In our view, however, China deserves more credit than blame for its recent actions.
As China attempts to make the transition to a more open economy, two things are virtually inevitable: market volatility and extremely difficult policy decisions, many of which need to be taken in the heat of the moment.
A case in point is the government intervention that followed the initial correction in the A shares market in July. This was widely interpreted outside China as a panicky reaction. But China’s share market is largely retail driven, and the need to maintain social harmony is of paramount importance to a single-party state. In light of this, the government’s response makes sense.
But what do we make of China’s decision to devalue its currency last month, just weeks before President Xi was due to make his first official visit to the US? The move was widely characterized as an attempt by China to shore up its sputtering export performance. Given that US politicians have for years accused China of keeping the renminbi artificially low, and that bilateral trade will be a key talking point when President Xi meets President Obama, surely the timing of the move was, at the very least, politically inept?
We don’t think so. In our view, the currency adjustment provides another example of how easy it is to misinterpret China’s policy actions.
Devaluation? Or a Step in the Right Direction?
Describing the move as a competitive devaluation ignores a number of facts—such as that China’s exports, while challenged, have largely performed better than those of its regional competitors. For this reason alone, it’s hard to see why a competitive devaluation would be necessary.
Also, China’s trade balance is positive (imports are falling faster than exports) and the country has an embarrassingly large trade surplus. Devaluation would simply exacerbate these issues, and do so at precisely the wrong political moment.
Far more plausible, from our point of view, is the explanation by the People’s Bank of China that the adjustment was intended to close an unusually large gap between the currency fix and the spot price. This made sense given that the central bank lowered the fix by just 1.9% and stepped into the market to support the currency when it came under pressure as the devaluation story took hold.
It also made sense as a reflection of government policy, which is to modernize and diversify the economy using private capital from inside and outside the country. To do this, China needs a more market-oriented currency—hence the move to align the fix more closely with the spot price.
Good News, Mr. President
Our research suggests that China is in fact less focused on its currency than on the need to deliver liquidity into the right parts of the domestic economy so that consumption becomes more of a growth driver alongside the traditional engines of exports and investment.
President Xi can tell President Obama some good news in this respect: recent data show a convergence in fixed-asset investment and retail sales trends, with the former falling and the latter holding steady (Display). While the figures are not particularly exciting in themselves, they suggest that China’s economic rebalancing is under way.
And that will be a welcome development for world trade, as it suggests that China’s consumers—the most affluent of whom are already making their mark in the purchase of international travel and foreign luxury goods—will continue their ascendancy.
(c) Alliance Bernstein