By Michael Lelyveld
China is struggling to find the right mix of economic, monetary and currency policies to escape major damage following Britain’s decision to quit the European Union.
At last week’s World Economic Forum in the northeastern city of Tianjin, Premier Li Keqiang pledged to maintain stability in the crisis, but it was unclear how it would be achieved.
“Like the Chinese economy, China’s capital market will unavoidably see some short-term fluctuations in some fields, but we have to guard against wild swings like skyrocketing rises or precipitous falls,” Premier Li said.
Li called for international cooperation to “reduce market panic and maintain market stability,” the official Xinhua news agency reported.
Experts say China is likely to remain a relative bystander in the worldwide turmoil triggered by the June 23 “Brexit” referendum.
Last year, the EU accounted for more than 15 percent of China’s trade, but the United Kingdom represented less than 14 percent of the EU’s total, according to Chinese customs data.
Direct effects of the meltdown in western markets may be limited for China, at least in the immediate term.
In the seven days since the start of the Brexit voting, the yuan was down 1 percent against the U.S. dollar in People’s Bank of China (PBOC) daily fixings, regaining some of the lost ground by midweek as western markets recovered.
Over the same period, the Shanghai Composite Index was up 1.3 percent.
U.S. markets opened the holiday-shortened week Tuesday with more nervousness about the yuan, which has fallen to its lowest level against the U.S. dollar since December 2010, CNN Money said.
More serious effects
But China has been bracing for the secondary, and potentially more serious, “next Brexit” effects.
With China’s exports already down 1.8 percent in the first five months of this year, any further drag on global demand could spell trouble, despite the diminishing role of exports in the country’s economic growth.
In comments quoted by the BBC, Finance Minister Lou Jiwei said that the “repercussions” of Brexit will be felt over the next five to 10 years.
Much will depend on whether major market losses are still to come, risking an international recession, and whether countries respond with protectionist measures, said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.
“That can’t be good for China, because the country has relied so heavily on growing export markets for its prosperity over the last 25 years,” Hufbauer said in an interview.
“This would put an end to that channel of growth,” he said.
Investors watching closely
Investors have been watching closely to see how the PBOC will manage monetary policies, capital controls and exchange rates in the face of added pressures.
China has repeatedly promised not to devalue the yuan for the sake of boosting exports, but the currency had already broken through the psychological barrier of 6.6 to the U.S. dollar in the daily fixing on June 15, more than a week before the Brexit vote.
Some economists have warned that depreciation will spur capital flight.
But with Brexit, traders have driven up the value of safer currencies like the U.S. dollar and the Japanese yen, making it costly for the PBOC to defend the yuan, whether its responses are motivated by export concerns or not.
The combination of contradictory pressures and China’s lack of transparency have made the course of its policies hard to read.
Top officials sent seemingly conflicting signals on China’s capital controls in the immediate aftermath of the Brexit upheaval.
Speaking at an International Monetary Fund forum in New York on the first day of the crisis, PBOC Governor Zhou Xiaochuan stressed China’s plans for economic liberalization and opening up.
“China will continue to promote (a) more flexible exchange rate, free flows in capital and current accounts, convenient convertibility between Chinese currency and foreign currencies, and to provide more risk-management instruments for both domestic and international investors,” Xinhua quoted Zhou as saying on June 24.
Three days later at the “Summer Davos” meeting in Tianjin, Premier Li repeated the opening-up theme but appeared to put greater emphasis to keeping the yuan “generally stable within a reasonable and proper range,” suggesting tighter anti- crisis controls.
‘Complexity of the current situation’
On Monday, the PBOC issued another boilerplate statement that promised to keep monetary policy “neither too loose nor too tight,” Xinhua reported.
But the central bank also warned that the “complexity of (the) current situation should not be underestimated,” citing international risks.
“There’s a great deal of uncertainty about how to move forward. There’s a great deal of tension between long-term objectives and short-term adjustments,” said Thomas Rawski, an economics and history professor at University of Pittsburgh.
“It’s not surprising that mixed messages come out, especially when you have this quite unexpected event staring them in the face,” Rawski said.
It seems likely that Zhou’s prepared speech to an IMF audience highlighted the parts of China’s familiar policy formulas that the IMF wanted to hear at a time when the fund is preparing to include the yuan in its Special Drawing Rights basket of freely-traded currencies in October.
Days later, as the dimensions of the Brexit debacle became clearer, Li shifted the policy message to sound the notes of control and stability that investors may want to hear. But neither statement can be relied upon to predict what China will do if pressures increase.
On June 24, the PBOC also posted a statement on its website, giving assurances that the bank had already prepared a crisis plan, insisting both that it would “keep the yuan stable within a reasonable range” and “let the market play a bigger role in determining the yuan exchange rate.”
The watchword is caution
While the narrow path of the policies may stray quickly into contradiction, there is little expectation that the government will risk further loosening of capital controls as long as the Brexit threat persists.
“I would expect caution to be the watchword,” said Rawski.”This government in China has not had a high propensity to step boldly forward into substantial or dramatic reforms.”
China largely escaped the effects of the last global recession by launching a massive 4-trillion yuan (U.S. $600-billion) infrastructure spending and stimulus program in 2008-09.
Although this year’s bank lending and infrastructure spending plans may actually be larger, another stimulus is unlikely to work this time due to higher debt levels and lower returns from excess liquidity already in the economy.
But the last bridge over troubled waters may encourage China’s leaders to seek some other remedy to keep the economy exempt from an international slump.
“They are striving to maintain domestic growth at high rates regardless of what’s going on outside. That has been their consistent pattern,” Rawski said.
The latest readings from Purchasing Manager Index (PMI) surveys last week suggest weakness in manufacturing.
The official PMI of larger enterprises slipped slightly from 50.1 in May to 50 in June, straddling the line between expansion and contraction.
Caixin Media’s private PMI survey of smaller and mid-sized companies found further slippage, falling from 49.2 in May to 48.6 in June.
Hufbauer thinks the government will try to ease economic pressures by cutting interest rates and the reserve requirement ratio (RRR) for banks.
The PBOC reduced the RRR five times last year and once so far this year. It has cut interest rates six times since November 2014, but the moves have so far failed to stop the erosion of economic growth.
China’s next-best plan for dealing with Brexit pressures may be to slow down liberalization in hopes of preserving a semblance of immunity.
In the initial shock wave that followed the Brexit bombshell, China analysts saw an upside for China in its isolation from free market economies due to its unfinished reforms.
“The yuan looks to stand out among currencies as the market isn’t fully opened yet to global investors,” said Li Liuyang, an analyst at Bank of Tokyo-Mitsubishi UFJ (China) Ltd., as quoted by Bloomberg News.
“China is well placed to weather any post-Brexit selloff in the financial markets because China’s capital account remains largely closed and the financial linkages between China and the rest of the world are fairly limited,” said London-based Capital Economics in a report cited by the official English-language China Daily.