How low can China go?

With China’s surprise devaluations of the yuan this week sending currencies, from the baht to the Korean won, tumbling across the region, one economic reality is increasingly clear. The Chinese economy is sputtering, perhaps more than the official numbers show, and Beijing is struggling to find a solution.

The latest disappointing Chinese trade data may well have contributed to the Chinese central bank’s move. The record 1.9-per-cent devaluation on Tuesday was followed by further cuts of 1.6 per cent on Wednesday and 1.1 per cent yesterday, which sent the Chinese currency tumbling at its fastest rate since 2001, potentially aiding Chinese exporters.

The move, however, may spark a regional “currency war” should other exporting nations, particularly in Southeast and East Asia, feel compelled to lower the value of their currencies to help domestic companies remain competitive with lower-priced Chinese goods.

Yet, “How low can China go?” is only the latest question being raised about China’s commitment to its 2013 pledge to “give a decisive role to markets” in its economy. Talk persists of a possible Chinese stimulus programme and “quantitative easing with Chinese characteristics” to spur the nation’s slowing, but still growing, economy. Such questions are understandable as Beijing still struggles with its ongoing interventions in its equity markets. 

A month after Chinese stocks lost trillions of dollars in value as prices plummeted to lows not seen since the global financial crisis, tremendous volatility remains a core theme for today’s China.

What’s clear is that no matter how large the Chinese government’s wallet to finance purchases and how strong the government’s ability to order brokerages to do its bidding or even to devalue its currency, more state money and less will power for reform are not the long-term solutions to China’s ongoing woes.

Direct and indirect government involvement to help shore up stock prices and placate the Chinese small-scale shareholders who dominate the marketplace has included allowing some shares not to trade, the suspension of new IPOs, financial support for brokerages and the establishment of a market-stabilisation fund to help inject funds into the market. In a further attempt to reduce volatility, China recently banned same-day margin lending, as well as barring some accounts under the control of US hedge fund Citadel and even China’s state-owned Citic Securities from trading for three months.

 

Two broad steps 

Even in a “command economy” with trillions of dollars in reserves, it would be a mistake for China’s leadership to think that central government’s ability to “command” domestic behaviour can replace the fundamental need for changes and continued reform. 

So, what can Beijing do to win back confidence in its economy? With the “little Bric” of excessive bureaucracy, poorly conceived or enforced regulation, increased interventionism and persistent corruption taking their toll, here are two broad steps that China should take.

First, Beijing must recommit to the opening of its financial markets and to a deepening of capital market reforms. This is well in line with the one-time pledge to give a decisive role to markets, and is also in line with President Xi Jinping’s “Chinese Dream” and goal of a “moderately well off society” by 2020.

Last year, China’s State Council announced it would move forward on a number of financial reforms. These included making progress towards direct bond issuances by local governments, removing some of the limits on using financial derivatives, and streamlining the approval process for IPOs as well as increasing quotas for both inward and outward foreign investment. 

Some progress has already been made with innovations, including the introduction last November of Shanghai-Hong Kong Stock Connect. While subject to quotas, this link between the Shanghai Stock Exchange and the Hong Kong Stock Exchange has increased two-way market access and should be built on.

Second, China must allow more of its businesses and entrepreneurs to succeed or to fail on their own. With every market intervention, investors may well be left wondering whether any business will ultimately succeed based on its fundamental merits versus government involvement, including the ability of the central bank to intervene forcefully in currency markets.

Already, it is clear that the nation’s stock markets are now reliant on official support, and shareholders eager to sell are being prevented from doing so, for now. With a continuing lack of transparency in the level and duration of government support measures, volatility persists. 

While the recent focus has been understandably on the nation’s equity markets, China’s credit markets also need to be allowed to continue to mature – onshore and offshore. This will include permitting Chinese companies, including state-owned enterprises, to default on corporate bond payments.

As with the United States’ own bailouts and market interventions during the global financial crisis, decisions taken in the heat of moment will be debated and second-guessed down the road. This will be true for China.

That is no reason though for China to avoid concentrating on the broader economic reforms that others in the Asia-Pacific region have slowly come to embrace. This will include continuing to take steps to build an enabling environment for the private sector – one marked by strengthened rule of law, greater transparency and accountability, and best practices in corporate governance. Such a commitment would in the long run benefit all of China’s listed companies and can help drive long-time growth and job creation.

China certainly has the power to intervene in its own markets.  The nation also has the power to go lower, further devaluing its own currency – to the detriment of many of its Asian neighbours. More important, however, will be the will power to refrain from such interventionism in favour of pursuing the fundamental changes and continued reform that will help ensure more sustainable growth and greater comfort with China’s long-term economic rise.

 

Curtis S Chin, a former US Ambassador to and member of the board of directors of the Asian Development Bank, is managing director of advisory firm RiverPeak Group, LLC. Find him on Twitter at @CurtisSChin.