Experts call for policy clarity for yuan exchange rate system to restore investor confidence

Economists expect no hard landing for the mainland economy in 2016, but say it's critical for the

authorities to improve communication with the market in order to restore confidence in the renminbi and prevent self-reinforced outflow.

"China's exchange rate policy has been at the center of recent market volatility. If the turbulence persists, it may become self-fulfilling and have a real effect on the economy," Paul Gruenwald, Asia-Pacific chief economist at Standard & Poor's ratings services, said on Thursday.

The mainland authorities, he said, need to improve clarity in the new exchange regime to earn investors' trust. That will include how the daily fixing rate is counted and what their intervention policy will be. "The market doesn't like any information vacuum. Investors tend to assume the worst, sell first and ask questions later."

The rating agency forecast that China's gross domestic production (GDP) growth will slow to 6.3 percent this year and to 6.1 percent in 2017.

China's GDP reached 67.7 trillion yuan ($10.3 billion) last year, with the services sector contributing 50.5 percent, the first time it had exceeded 50 percent, outstripping the once-dominating manufacturing sector by 10 percentage points.

Gruenwald added that China, a largely self-funded economy, is better cushioned for shocks compared with other emerging markets which rely on external funding. As the country's capital account is not open, potential portfolio outflow would be "relatively small" despite domestic market volatility.

On the country's fiscal deficit, Gruenwald said it's still affordable although China is no longer a low-debt economy. "The government needs to focus on speeding up restructuring and stimulating the services sector in the next one to two years."

In the face of a decelerating economy, Chris Leung, senior economist at DBS, believes the renminbi's depreciation is largely inevitable. The bank estimates the redback is overvalued by 8 percent.

However, for fear that market overreaction would lead to massive capital outflow, the People's Bank of China (PBOC) could not allow a sharp depreciation of the currency, and has to engineer a relatively stable exchange rate, Leung said.

But, such a guideline is continuously consuming China's foreign exchange reserves unless the PBOC can bring back the confidence of global investors as well as the central bank's confidence in the currency by clarifying its policy direction, he said.

He added that the country's declining foreign exchange reserves could spoil the government's previous efforts to have the renminbi included in the Special Drawing Right currency basket of the International Monetary Fund (IMF).

The IMF's foreign exchange adequacy metric indicates that China should have at least $2.6 trillion in its coffers. But the country's foreign exchange reserves had shrunk from a peak of $3.99 trillion in June 2014 to $3.33 trillion at the end of 2015. In December alone, the reserves had dropped by $108 billion.

"At such a rate, the reserves will hit $3 trillion this April," Leung said.

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Hard landing for mainland ruled out

Experts have urged the central government to improve clarity in the new renminbi exchange regime so that investors' confidence in the system can be restored. Kim Kyung-Hoon / Reuters

(HK Edition 01/29/2016 page8)

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