MNI INTERVIEW: PBOC Tempted To Weaken Yuan If Rebound Falters

The People’s Bank of China could be “strongly tempted” to again use state-owned banks to weaken the yuan, disguising Beijing’s attempts to boost exports through a cheaper currency should the rebound in consumption and the property market falter, former U.S. Treasury economist Brad Setser told MNI.

“The real test will come if this rebound proves underwhelming”, Setser, now a senior fellow at the Council on Foreign Relation, said in an interview. The PBOC “would be very tempted to boost the export machine through weakening the yuan via off-balance sheet methods,” he said. (See MNI: China’s Prudent Targets, Stimulus Show Risks To Recovery)

“If U.S. inflation and interest rates stabilise, the re-opening, lower oil prices, and a renewed interest in Chinese equities all point to the potential for a stronger yuan, which will hurt exports further”. The growing number of Chinese tourists traveling internationally this year could drain CNY100 billion from foreign reserves, but this largely would be offset by falling import commodity prices, he said.

Setser’s research highlights the use of state banks to buy and sell dollar reserves to steer the yuan’s movements under instruction from Beijing.

In 2021, the net foreign assets of state banks increased by USD233 billion, while "FX settlement" - which in theory includes both the state banks and the PBOC - increased by USD289 billion once adjustments are made for forward transactions. In 2022, the net foreign assets of the state banks increased by only $11b, and FX settlement, again adjusted for forwards, rose USD88 billion.

“Data suggests this practice started in 2015 when large decreases in the central bank's FX stockpile spooked investors” said Setser, adding the yuan would have depreciated more in 2022 if it wasn't for state bank support while PBOC official reserves remained stable.

TRADE TENSIONS

Any attempt to weaken the yuan could stoke already combustible trade relations between the US and China. Setser sees the possibility of another flare-up if China’s current account surplus, which totalled USD417 billion in 2022, remains at elevated levels and Donald Trump is nominated as the Republican Party’s presidential candidate.

China’s current account surplus may be USD200 billion higher than official figures, according to analysis done by Setser on China’s customs data. There is a large gap between the customs data and the official balance of payments calculations.

“This indicates there is real underlying strength in China’s trade balance” he said, warning serious questions will be asked in Washington if the surplus remains elevated.

“Sino-US trade relations will also depend on the success of the Biden administration's efforts to friend-shore, in particular decoupling from China on rare earths refining,” he said, although vast amounts of consumer goods and agricultural products will continue to be traded.

“If the US can develop electric vehicles with limited inputs from China is also an important factor to consider,” he said.

Setser does not see China’s current account surplus coming down over the long-term unless structural reforms are made.

“Economies that save over 40% of GDP tend to have strong current account surplus” he said. “Unless China brings down its savings rate through more transfers, it will be hard to see the surplus coming down significantly.”

TREASURY HOLDINGS

Despite tensions with the US, Setser sees no decrease in China’s holding of US government bonds over past years, only the transfer of some holdings into custodian accounts held in Belgium, a move he believes is designed to obscure China’s holdings and decrease geo-political sensitivities.

Overall holdings of US bonds have not gone down because “there is no other asset class big enough”, Setser said, adding that the holder of USD1.5 trillion in US government and GSE (Agency) bonds can't go anywhere else without buying up that whole market.