Investors have been fearful of the market fallout from a rise in US official rates in September or December. In the event, it has been the unfixing of another central bank-controlled price – the RMB / US dollar exchange rate – that has triggered turmoil.
The official explanation is that the change to the daily fixing mechanism is intended to allow the currency to be more market-driven. The question is what is meant by “more”. The only formal constraint on depreciation imposed by the new mechanism is that onshore spot can fall by no more than 2% per day. If the market were allowed free rein, the currency would probably move 10-20% lower in short order, causing major global financial and economic disruption.
The majority view is that the authorities will step in to prevent a decline of more than about 5%, suggesting that the market-driven regime will last only one more day, given a 3.5% drop over Tuesday-Wednesday. A larger fall is deemed unlikely because:
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A big devaluation, if it were desired, would have occurred instantly.
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A lower currency is unlikely to boost exports and growth much, if at all, because of parallel depreciations of EM competitor currencies and negative global financial / economic spillovers.
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The authorities have stepped up fiscal easing recently and are probably relying on this, rather than an export boost, to revive growth.
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A big fall would displease the US administration, threatening a veto of RMB inclusion in the SDR – a key official goal.
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A big decline would run counter to desired economic “rebalancing” from exports / low value-added manufacturing to consumption / services.
The majority view is plausible but confidence in the authorities has been shaken by the recent stock market debacle. There is also concern that the decision to unpeg the currency is the result of an internal power struggle and there may not be a coherent longer-term plan.
The currency announcement has overshadowed economic / monetary data suggesting that growth remains weak but has recovered since early 2015:
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Annual industrial output growth was 6.0% in July versus 6.8% in June but the decline reflected an unfavourable base effect. Output was unchanged month-on-month in July following a large 1.5% gain in June. Six-month growth has revived to 3.5% from a low of 1.8% in March – see first chart*.
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Housing demand continues to recover, with sales volume up by an annual 21% in July.
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Six-month growth of real (i.e. CPI-adjusted) M2 rose to its highest since October 2012 in July, partly reflecting “stock market QE” – officially-ordered bank loans to other financial institutions to fund price-keeping operations.
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Core CPI inflation – excluding food and energy – was stable at 1.7% in July; producer price deflation mainly reflects commodity price weakness – second chart.
Global equity markets may remain under pressure until the RMB stabilises and policy intentions become clearer. The liquidity backdrop, however, is still supportive, with global real money growth – on both narrow and broad definitions – respectable and well ahead of output expansion. Bears are making comparisons with the 1997-98 Asian currency crisis but this actually proved positive for global stocks as Fed tightening was aborted – the MSCI All-Country World index rose by 12% in US dollar terms in the 12 months following the breaking of the Thai baht / dollar peg on 2 July 1997.
*Based on World Bank seasonally-adjusted level data.
