14 Jan 2016
China: Escaping the horns of a Trilemma - ING
FXStreet (Delhi) – Tim Condon, Chief Economist at ING, expects the Chinese authorities to tighten capital controls to defend US$3tr of FX reserves, cut interest rates and avoid a large CNY depreciation.
Key Quotes
“Yesterday’s December trade data, which put the full-year trade surplus at a record US$595bn, underscored that hot money outflows drove the US$513bn drop in foreign exchange reserves last year. The PBOC evidently intervened heavily to curb CNY depreciation pressure.
The authorities are caught on the horns of a trilemma. They’re “only” US$330bn away from US$3tr of foreign exchange reserves, which we believe is a line in the sand. We also believe the authorities don’t want a large CNY depreciation. Further, we believe they want lower interest rates to support growth. The trilemma of international finance holds that a country cannot simultaneously allow free capital flows, pursue an autonomous monetary policy and fix its exchange rate.
We expect the authorities to resolve the trilemma using command and control policies. In particular, we think they will put restrictions on international capital flows. We saw initial signs that this was where things were going in late December when the PBOC suspended some foreign banks from trading USDCNY and USDCNH. More recently, the press reported that SAFE verbally instructed banks operating onshore to limit USDCNY buying and reduce USDCNH positions. This week Premier Li told a State Council meeting on anti-graft works that there was a need to crack down on “financial violators.” Banks’ currency trading activities could be investigated.
Economic reform frequently is a two steps forward, one step back process. Capital account opening took two steps forward in the first three years of the Xi administration. We think 2016 will be a year of one step back.
December money and credit data may be released anytime today or tomorrow. The consensus forecast for new bank loans is CNY700bn. The forecast for aggregate financing is CNY1.15tr.
The statement from the December Central Economic Work Conference noted the need of more flexible monetary policy to facilitate structural reforms and lower business costs, which we think means interest rates. We forecast a cumulative 50bp of PBOC policy rate cuts by mid-year, taking the 1-year lending rate to 3.85% (latest 4.35%, Bloomberg median 4.10%).”
Key Quotes
“Yesterday’s December trade data, which put the full-year trade surplus at a record US$595bn, underscored that hot money outflows drove the US$513bn drop in foreign exchange reserves last year. The PBOC evidently intervened heavily to curb CNY depreciation pressure.
The authorities are caught on the horns of a trilemma. They’re “only” US$330bn away from US$3tr of foreign exchange reserves, which we believe is a line in the sand. We also believe the authorities don’t want a large CNY depreciation. Further, we believe they want lower interest rates to support growth. The trilemma of international finance holds that a country cannot simultaneously allow free capital flows, pursue an autonomous monetary policy and fix its exchange rate.
We expect the authorities to resolve the trilemma using command and control policies. In particular, we think they will put restrictions on international capital flows. We saw initial signs that this was where things were going in late December when the PBOC suspended some foreign banks from trading USDCNY and USDCNH. More recently, the press reported that SAFE verbally instructed banks operating onshore to limit USDCNY buying and reduce USDCNH positions. This week Premier Li told a State Council meeting on anti-graft works that there was a need to crack down on “financial violators.” Banks’ currency trading activities could be investigated.
Economic reform frequently is a two steps forward, one step back process. Capital account opening took two steps forward in the first three years of the Xi administration. We think 2016 will be a year of one step back.
December money and credit data may be released anytime today or tomorrow. The consensus forecast for new bank loans is CNY700bn. The forecast for aggregate financing is CNY1.15tr.
The statement from the December Central Economic Work Conference noted the need of more flexible monetary policy to facilitate structural reforms and lower business costs, which we think means interest rates. We forecast a cumulative 50bp of PBOC policy rate cuts by mid-year, taking the 1-year lending rate to 3.85% (latest 4.35%, Bloomberg median 4.10%).”