The weak Renminbi explains the Chinese stock market sell-off

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Sara Salim's picture

Shortfalls in the Renminbi are agitating markets, while Chinese authorities struggle to contain massive stock market sell-offs amidst concerns of a Chinese slowdown. Current economic drivers are negative toward the Renminbi vis-à-vis the currency not being the steady, tightly controlled currency it once was. It is more market-driven, with less official intervention and investors must accept that Renminbi volatility is the new normal. There are two Renminbi rates – the offshore CNH used internationally which is effectively a proxy for the fears of the events in the Chinese economy, and the onshore CNY which trades in a band dictated by the PBoC's daily rate. The PBoC has been loosening this band and while weakness is expected, the pace is surprising - far faster than markets expected. The CNH and CNY rate has widened, which is upsetting the International Monetary Fund since the aim is to unify the two after the decision on 30 November to add the CNY to the Special Drawing Rights basket.

This grave worry is resonating throughout the world, and is behind the current Chinese stock market plunge. China was the consumer or investor of last resort over the last few years, keeping things in order when other countries were too weak. Today, there is no obvious replacement. Traditionally, it was US, but this stopped post financial crisis. For many years now, Chinese authorities have been trying to widen equity ownership for its people but it is easy to go too far- just like the US' effort to expand home ownership that brought about the 2008 financial crisis. Too far has China gone, creating today’s current unsustainable economic situation. Diminishing marginal returns has set into the economy. Chinese companies are not able to flood international markets with its cheap products to support more expansion, causing its economy to lose its once important source of growth and employment. Naturally, this comes with the erosion of the government's capacity to meddle with markets through price distortions. China is mirroring what crisis-struck nations resorted to after the financial crisis. The US depended on expansionary monetary policy with near-zero interest rates which weakened the USD, giving exports a boost. We witness a similar scenario in the Eurozone, where the European Central Bank is still engaging in quantitative easing.

However, the crucial difference here is that China needs to balance its domestic economic interests with the aftermath its actions have on the international economy. For instance, Central Banks in the (currently weak) emerging markets of Asia’s monetary policies will be more aligned to policy cycles in China compared to previously where they closely followed the US Federal Reserve. Asian exports are now more reliant on Chinese domestic demand, with share of exports to China being on par with the US. A slowdown in China offsets any potential boost from the US' recovery. Weaker Chinese investments further impact Asian economies via weak commodity prices such as industrial metals, which are main exports of these economies. As China’s industrial exporters move away from exporting cheap consumer durables to exporting high-tech machinery, economies like Korea and Taiwan will feel the pinch by being “crowded out” by China should the weaker Renminbi translate into cheaper Chinese exports.

There will come a time when the Renminbi is on the same footing and esteem as its peers in the IMF's Special Drawing Rights basket of currencies. The Renminbi will find acceptance that it truly is a (or even, is the) major currency in global markets. China’s domestic and international responsibilities are more likely to be aligned and they will be greatly obliged to maintain global financial stability. The time, however, is not now, and this weakness is for the medium-term. 

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