Higher economic growth or a more stable yuan?

THE DECISION by the People’s Bank of China (PBOC) last week to cut the reserve-requirement ratio by 50 basis points once again reflected the recent change in strategic priorities related to macroeconomic problems. 

The move allows Chinese banks to increase lending to the tune of about US$107 billion (Bt3.8 trillion) in total and enhance liquidity in the economy. 

The liquidity problems were caused by the intervention of the PBOC in the foreign-exchange market in order to stabilise the yuan against capital outflows. Therefore, the policy to stimulate economic growth seems to be about assigning more weight than about currency stabilisation.

Enhancing the ability of banks to lend more will allow some small and medium-sized enterprises with financial problems to remain in business. However, it is unlikely the move will be effective in stimulating the real economy, because during a global economic downturn most entrepreneurs tend to play it safe and not invest as much. The measure to reduce the reserve-requirement ratio to enhance the ability of banks to lend more is not targeted at any particular activities. Thus the banks can increase lending to businesses that may not have been targeted by the government from the beginning. 

As a result, more loans can be given to financial and property speculators. In this aspect, the speculation problem becomes more aggravated. 

More capital outflow from China will result in the yuan depreciating further. If the PBOC wants to stabilise the yuan, it will need to sell more US dollars and absorb more yuan out of the economy. 

This would mean that China’s foreign-exchange reserves could be reduced further, while the need to protect the yuan from depreciation would partly negate the impact of reducing the reserve requirement ratio. 

Therefore, we may be able to conclude the following: 

lEventually the PBOC will not be able to maintain the negative impact of capital outflow on the yuan by relying only on the existing foreign-exchange reserves.

lIf the US central bank does not raise the Fed funds rate as much as planned, it will not aggravate the pressure on capital outflows in China. 

lIf the additional quantitative-easing (QE) measure of the European Central Bank (ECB) cannot sufficiently increase the money supply to the global economy, it will not be able to stop the outflow of capital from China.

In summary, it is important to realise that the outcome of the QE measures from the ECB’s meeting on Thursday and the US Federal Reserve’s decision on the policy rate on March 15 may also inform us about the future direction of the yuan and, hence, the related impacts on the Thai baht and other major Asian currencies.

 

Professor Arayah Preechametta is a lecturer at the Faculty of Economics, Thammasat University.