Is pragmatism going to trump ideology in Beijing?
That’s the big question Yu Ming Wang, Nikko Asset Management’s global head of investment and chief investment officer international, and his team have asked themselves in their latest research note.
It’s an interesting question that cuts to the core of the debate surrounding the battle over the value of China’s currency, the yuan. It’s also a question that underscores the battle between China’s central bank, the PBOC, and hedge funds who think the yuan could fall by 25% or more.
Just this past weekend China’s Central Bank governor Zhou Xiaochuan warned neither he, nor the PBOC, would be held hostage by speculators. He said there was no reason for a devaluation given 2015’s $600 billion trade surplus. He also said that “at the moment the level of cross-border capital flows is within the normal region”.
That warning was followed by action this week with China’s central bank, the PBOC, surprising traders by driving the yuan 0.9% higher against the US dollar compared to the pre-Lunar New Year holiday on both Monday and Friday.
Why China wants to keep its currency strong when other central banks, like the ECB, Bank of Japan and even the Reserve Bank of Australia, are engaged in a race to the bottom – a currency war – to force their currencies lower, and so enjoy the economic benefits a lower exchange rate brings, is an open question.
But it’s the wrong question according to Wang. He says the big issue for China, and its Communist Party rulers (CCP), is whether pragmatism or ideology is going to win out when it comes to the yuan’s value.
He noted that “the probability of a large one-off devaluation, potentially accompanied by a swathe of financial reforms including a free float of the RMB, is on the rise. Fighting capital outflows by spending FX reserves may postpone the problem, but it does not solve the fundamental issue of a manipulated high exchange rate while the real economy decelerates”.
Yet while the economy demands a weaker yuan, policy makers are fighting market forces, Wang says. That because to do otherwise “runs against the ethos of the Communist Party regime in terms of retaining ultimate control”.
In the end though, Wang suggests that the odds of China letting the yuan float or undertaking a big devaluation are growing. After all, in the past year governments and central banks all over the globe have increasingly dumped ideology for pragmatism.
“Over the past year, markets have been surprised by Saudi Arabia abandoning OPEC, the European Central Bank’s ‘whatever it takes’ approach and the Bank of Japan’s latest gamble with negative interest rates,” Wang said.
“In the current environment, the Fed reversing monetary policy and the PBOC letting the RMB free float might not be so unbelievable after all.”