RMB float to ease risks, experts say

Renminbi has slid to its weakest level since the global financial crisis in 2008

Allowing the renminbi exchange rate to float more freely could be a wise choice for China in the face of trade conflicts and economic downside risks, according to experts.

By analyzing recent signals from the authorities, as well as market performance, they believe the government much prefers a freer RMB, or wants the market to decide its value.

The monetary authority seems to face a dilemma: Defend the currency by tightening liquidity, which may lead to credit defaults and the fast bursting of asset bubbles, or tolerate a relatively weaker currency against the US dollar, though ensuring that a low interest rate could sustain strong economic growth.

At the same time, experts are concerned that further tightening the monetary environment could hurt asset prices, especially housing prices.

"You don't need to make the RMB stronger than it should be, as the dollar is surging in its value, when money is sucked into the US amid interest rate hikes and monetary policy normalization," says Huang Yukon, senior associate of the Asia program at the Carnegie Endowment for International Peace and former China director for the World Bank.

On Oct 30, the RMB slid to its weakest level since the global financial crisis. Its daily reference rate, which bands the onshore RMB's moves within 2 percent on either side, dropped to 6.9574 per dollar, the lowest in more than a decade.

Referring to a psychological threshold for foreign exchange rate traders of 7 yuan per dollar, Gao Haihong, an economist at the Chinese Academy of Social Sciences, says: "To set a certain threshold is unnecessary, and 7 yuan per dollar is not the target of the central bank. The main focus of the monetary policy is domestic targets, especially to stabilize growth and demand."

Some experience has shown that, when the monetary authority chooses to target an exchange rate within a certain range, interest rates and conditions in the domestic economy must adapt to accommodate this target, and domestic interest rates and money supply can become more volatile.

As the US Federal Reserve is expected to implement the fourth rate hike this year in December, some analysts speculate that the narrowed China-US interest rate gap may trigger more capital outflows from China and increase downward pressure on domestic asset prices.

"Compared with a currency under pressure, the bursting of an asset bubble is a more serious problem, and policymakers need to be very careful about the monetary policy to prevent tightening too much," says Yoshiki Takeuchi, director-general of the International Bureau of Japan's Ministry of Finance.

"If the policy is too tight, people will expect a bubble to burst in the property market. Japan used to raise the interest rates and constrain money coming into the banking sector, but it was too hasty in doing so, which has led to the property market slump." Since domestic consumption is now leading the Chinese economy, stabilizing property prices is important," says Takeuchi.

Besides, a good method for avoiding bubble bursts is not to make bubbles. It requires policymakers to continually push forward the deleveraging process and to control debt growth at a lower pace, according to analysts.

Amid the trade tensions, China's domestic demand is growing significantly faster than that of its trading partners, thus its imports tend to outpace exports. The country's current account balance is subject to downward pressure.

"The shrinkage of the account surplus will be a constraint on the policy stance with regard to capital opening in general and financial outflows in particular," says Louis Kuijs, head of Asia economics at Oxford Economics.

"It will have an impact on views regarding financial stability, onshore RMB sentiment and the policy approach to capital account opening," he says.