Trusting China Requires More Than Yuan Reform

Trusting China Requires More Than Yuan Reform

September 2016


The renminbi will soon be added to the International Monetary Fund’s (IMF) Special Drawing Rights basket of world reserve currencies. This decision comes after decades of impressive growth and adoption of important reforms in recent years, making China, by many metrics, a leader in global capital markets. This leadership role calls for further reforms that will transform both the Chinese economy and global markets.

Beijing now consistently provides the IMF with information on its currency holdings. It has announced that pre-approved foreign financial institutions will be allowed to operate in China’s domestic foreign exchange market, and it has unveiled plans to open up the domestic bond market to overseas investors. Certain Chinese citizens will also now be permitted to make direct cross-border investments.

Opinions at the recent China Development Forum about further policy steps were divided. While some participants chastised financial markets for their response to Chinese economic indicators, others pondered whether the Chinese economy was headed for a soft or hard landing and whether Beijing’s interventions in the market contributed to financial instability at home and internationally.

This debate is understandable. Unanticipated actions by China’s regulators over the last year have jolted investors and contributed to extreme volatility in global markets. China’s foreign exchange reserves have fallen to their lowest in more than three years and in the last year the People’s Bank of China (PBOC) used well over half a trillion dollars of its reserves to prevent further depreciation of the currency.

China’s willingness to reform

Many Chinese citizens seem convinced that the renminbi will lose more value in the future, prompting them to sell the currency, which in turn risks more downward pressure on its value and further depletion of reserves by the central bank.

The gloomy predictions heard in some quarters about the trajectory of China’s economy may be overblown. The steps taken by Beijing to liberalize private business, loosen currency controls, and allow greater freedom of investment certainly demonstrate willingness to reform.

At the same time, China can play its part in helping stabilize global financial markets by engaging in further reform at home. The tension between domestic economic stability based on government intervention and market reforms that create short-term pains but generate predictability in the long-term should be reconciled in favor of the latter. This shift is imperative as China enters a critical phase in its transition from an export and investment-driven to consumption-based growth model.

Beijing’s new role as a leader and one of the most consequential players in global capital markets comes with substantial responsibility. China is an engine for growth for economies around the world and will soon possess a global reserve currency. Consequently, Beijing has an opportunity to transform its economy through financial market reforms and greater openness. There are a number of steps to achieve this.

Greater transparency is needed

First, Beijing should exercise greater transparency in the financial system. Several voices were raised at the March meeting of the China Development Forum about the need for China to improve communication with the rest of the world. This is key. The failure to explain official intentions behind changes in exchange rate policy has created uncertainty and anxiety among investors and fostered speculation about a potential currency war.

Contrast this with the U.S. Federal Reserve and its December interest rate increase, which did not surprise markets. The Fed explained its rationale for the move openly and in detail, setting expectations and supporting predictability about the future.

In order to make sound decisions, investors need a better understanding of the roles, responsibilities, and authorities of Chinese regulatory institutions. These institutions should have common policy objectives and convey consistent and clear messages. It’s especially important for the PBOC, China’s securities regulator and the Commerce Ministry to show investors that they are on the same page about what these goals are and how they are working to achieve them.

More transparency in corporate governance and financial reporting is also needed, especially among state-owned enterprises. A good way to boost transparency is to liberalize the capital account for institutional investors from the U.S. and other consolidated market economies, which would reduce opacity and raise reporting standards.

Further changes

Second, China should achieve greater neutrality and independence of its regulatory policies and institutions, especially the PBOC. China’s central bank has certainly enhanced disclosure in some areas by issuing regular reports and even taking to social media. But it still needs to have its decisions approved by a number of other government institutions. Research has shown that independent central banks are more likely to make hard but necessary decisions about monetary policy and to sustain them over time.

Third, market interventions should be avoided. Since last summer, the securities regulator has taken action to support share prices and organized sizeable stock purchases to prop up the market. But this sort of intervention only contributes to existing imbalances and seldom works – as we saw when China abandoned circuit breakers earlier this year that had temporarily halted trading.

Finally, investors and properly functioning capital markets should be allowed to pick winners and losers on their own. Chinese securities regulator and other government agencies should not pressure investors to stop selling shares or buy renminbi.

In the U.S. and other established market economies, securities regulators are not there to halt new listings, convince companies and brokerages to purchase shares, or stop certain types of short selling. Beijing should look to these economies to better understand the markets and how to meet their expectations.

China would benefit significantly from taking these steps. They would help gain the trust of international investors and contribute to stabilizing the domestic economy. And they would underline China’s new responsibility as a leader in global capital markets.


This article was written by Capital Flows from Forbes and was legally licensed through the NewsCred publisher network.

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