The other big story in the Emerging Market (EM) world aside from the conflict in Ukraine/Russian conflict is the changing nature of the Chinese economy. The 2013 3rd Plenum, a meeting of Communist Party’s Central Committee, seemed to suggest a more market-driven philosophy to guiding China’s economy moving forward having massive consequences for China going forward. This week, I’ll be focusing on China.
So far, like other aspects of the Chinese economy, the RMB, has been state-controlled. China’s currency has been pegged to the US dollar at roughly 8 RMB to the dollar. Since exports are a large party of the Chinese economy – this matters greatly; a cheaper RMB (also known as Yuan/CNY) means cheaper, more competitive exports. However, currencies tend to appreciate with more exports, that is, with more Chinese exports in the global market, they should rise in price but the Chinese government has kept the currency artificially low by acquiring foreign reserves and thus masking the market value of the RMB for some time.
In 2005, under pressure from trading partners, China moved to a “managed float” system where the currency was allowed to have more volatile appreciation and the currency moved from 8 – 6.8 RMB/Dollar. The Chinese government stabilized the currency in 2008 due to the financial crisis but resumed appreciation trend in June 2010. During those times, daily volatility of the currency was limited at 0.5% per day.
In 2012 daily volatility moved to 1% and now it’s announced that 2% band for the RMB is possible. This is seen as a move to internationalize the RMB and for it to move closer to its market price. This move has already seen making a huge impact in the FX market (see chart).
The other big story in the Emerging Market (EM) world aside from the conflict in Ukraine/Russian conflict is the changing nature of the Chinese economy. The 2013 3rd Plenum, a meeting of Communist Party’s Central Committee, seemed to suggest a more market-driven philosophy to guiding China’s economy moving forward having massive consequences for China going forward.
This week, I’ll be focusing on China.
Slower, but more more stable growth
It’s not secret that China is slowing down. The average annual year-over-year GDP growth over the last 30 years has been around 10.14% but the last few years have seen a downward GDP trend. The most recent annual GDP number is 7.7% for 2012 and the finance officials forecast an even lower projection of 7.5% GDP growth for 2014. The PMI Manufacturing Index and Industrial Production numbers for China has so far disappointment in 2014.
But a lower GDP may be a good thing for China.
Growth in China has been so far been credit-fueled and investment-led, meaning that you have entities borrowing from investors to fund projects, especially property developments. However, this frenzy in simply building things with borrowed money can lead to the misallocation of capital personified by the rise ghost cities.
Investment has been a crucial, but unsustainable part of growth because it incurs debt: provincial government debt and the increase of shadow-banking, unregulated, off-balance sheet banking interactions. While providing additional liquidity, a lack of regulation and transparency threatens the stability of the overall financial system. So far, the central government has taken action in auditing provincial government financial activity but it’s unclear how much transparency there will be going forward.
A transition to a more consumer-led growth will provide a stable and fundamentally-led growth for the economy but probably not result in double-digit growth numbers we’re used to from China.