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China in a spot with Fed’s rate hike
Print Edition
THE US interest rate increase narrows the scope for China to balance currency stability with economic growth.
The Federal Reserve raised the benchmark interest rate by 25 basis points on Wednesday, the first increase since 2006, signaling the end of the era of monetary easing.
Both the employment and inflationary situations in the United States have improved, complicating the picture for emerging economies, struggling with anemic growth and dimming prospects.
“The key question for China in 2016 could be whether the country can reconcile potentially conflicting imperatives on domestic and external financial stability,” said Andrew Colquhoun, head of Asia-Pacific sovereigns at Fitch Ratings.
Rising corporate debt and softening domestic demand in China would justify lower interest rates, but with US rates increasing, rate cuts in China could precipitate a flight of capital in search of better returns, Colquhoun said.
The US rate hike was widely anticipated and most of its effects are already factored into China’s forex reserves and the yuan rate. Reserves fell by US$87.2 billion in November, the second-biggest monthly drop since 2011. The yuan central parity rate against the US dollar weakened yesterday to 6.4757, the lowest in more than four years.
The Fed’s action puts pressure on the yuan and squeezes China’s room for reducing interest rates, said Jiang Chao at Haitong Securities. Worse yet, capital outflows could hit a property market that is already depressed, with knock-on effects in shadow banking and on local government balance sheets.
A massive shock, however, would be exactly that: a shock. Third-quarter GDP growth of 6.9 percent is still much better than most other major economies and China’s forex reserves are still well above US$3 trillion — a huge shock absorber.
While not immune to the effects of the rate hike, China will naturally consume some forex reserves and see currency fluctuations, but the government is ready and willing to intervene if necessary, said Guan Qingyou at Minsheng Securities. “Out-of-control capital outflow is unthinkable,” he said in a note.
Financial markets have already priced in the Fed’s move and the yuan may “take a breather” in the short term, Guan said. In the long run, he said, the yuan will become more volatile as it becomes less dependent on the dollar.
China’s central bank has already signaled that the market should view the yuan’s strength relative to a basket of 13 currencies, including the dollar, euro and yen, a move aimed at more flexibility, making the yuan less susceptible to Fed policy, said UBS economist Wang Tao.
With higher US rates, China is under pressure to make its economy more competitive and appealing to foreign investors. To offset capital outflow risk, China should increase returns on domestic assets by stabilizing growth and accelerating structural reform, said Jiang.
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