MNI INTERVIEW: China Must Lift Growth To Curb Capital Outflow

Striking the right balance between pro-growth policies and Beijing’s Covid-Zero strategy will be crucial in delivering a recovery to restore confidence in China’s economy, curb capital outflows and support the yuan, former People’s Bank of China monetary policy committee member Yu Yongding told MNI.

Despite the yuan’s slide to a 15-year low against the U.S. dollar amid concerns about China’s outlook, the government still should allow the currency to be as flexible as possible and focus its efforts on reviving growth that will fall short of Beijing’s target of around 5.5% in 2022, said Yu.

“Macro policymakers’ main challenges are domestic, even though the rate hikes of the Federal Reserve have imposed some constraints,” said Yu, who is a former director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

“The priority at present is to boost GDP growth in the fourth quarter so as to restore markets’ confidence in China’s economy. To achieve this goal, China should continue its expansionary fiscal and monetary policy, despite the Fed’s interest rate hiking,” the prominent economist said.

Yu acknowledged capital outflow has weighed on the yuan, noting the currency’s slide had been driven by foreign investors selling Chinese bonds, Chinese citizens buying offshore securities and some capital flight on concerns about the outlook for growth.

Management of cross-border capital flows combined with a flexible foreign exchange rate policy was a “powerful policy tool” to safeguard financial stability, he said. Yu said the central bank should allow the yuan to move as flexibly as possible and not set up a “red line” at a certain level which could trigger arbitrage opportunities in the market. (See MNI INTERVIEW: PBOC FX Intervention Still An Option - Guan Tao)

“The current depreciation of the yuan against the dollar is short-term. Firstly, I do not think the Fed will raise the funds rate as aggressively as many pundits argue and the dollar appreciation is harmful for US external sustainability in the long run. Second, the performance of the yuan has been much better than other major currencies and China’s trade account is very robust,” he said. “Therefore, the central bank is right to conduct an exchange rate policy of 'benign neglect'.”

“However, the PBOC will be alert to excessive yuan weakness, which may pressure domestic inflation and threaten the ability of Chinese companies to pay overseas debts. Therefore, the PBOC will not rule out the possibility of occasional intervention,” he added. “The Hong Kong dollar could be in a vulnerable position at the moment, the PBOC should be vigilant,” he warned. (See MNI: A Sharply Weaker Yuan Looms As A Threat To China's Trade)

FISCAL DILEMMA

China relies on increasing infrastructure investment to stimulate the economy, but Yu said that investment isn’t done in an optimal way. He calculates that in 2021, the central government’s contribution through the general public budget to the total infrastructure funding was 0.1%, while funds raised from municipal-bond sales – which are far more expensive – accounted for more than 30% of total infrastructure funding. Yu said this funding structure makes China’s infrastructure investments far more costly than necessary and threatens local government’s fiscal sustainability.

“When the economy continues to drop and unemployment rises, the central government should increase its budget deficit, which is the lesser of two evils, ” the economist said. “Chinese experience has proved that higher GDP growth is an effective way to lower the macro leverage ratio.”

Yu said another problem with implementing expansionary fiscal policy was the lack of flexibility in using funds raised via local government special-purpose bonds (LGSBs). Local government like LGSBs because they are relatively cheap. However, the central government has imposed strict regulations on the use of the funds raised due to fears of misuse by local governments. This means governments that need funds for infrastructure investment let the funds sit idle. “How to strike a balance between the effective use of LGSBs funds and preventing moral hazard is very challenging,” Yu said.

TOUGH 2023

Yu said China faces a more complicated external environment in 2023 as the global economy slows under the weight of aggressive rate hikes and geopolitical tensions.

“There is no reason to feel optimistic about global economy in 2023,” he said.

He was concerned about China’s over USD3 trillion of reserves and reliance on exports as an engine of growth given increased U.S government debt, weaker U.S. growth, and other countries’ reduced holdings of U.S treasuries. He urged China to accelerate its “dual circulation strategy”, which seeks to increase domestic demand as an economic driver rather than exports.