The global markets, stock and money markets included, have been hit by unusual volatility since the start of the year. In some countries, the stock markets have begun to show apparent features of a technical bear market. Some analysts blamed it on China factors, citing its economic slowdown, continuing depreciation of the yuan (or renminbi), stock-market rout and a sharp rise in banking risks. There were also surging waves of shorting the yuan on the onshore and offshore markets.
In analyzing the domestic and international markets before the market opening in the Year of the Monkey (on the Chinese zodiac Lunar Calendar), Zhou Xiaochuan, governor of the central bank, put forward countermeasures. Premier Li Keqiang, at an executive meeting of the State Council, also said that the market-stabilizing principles and policies, adopted by the government to tide over unusual volatility in the stock and exchange market in 2015, were a right call. At the same time, the premier called on the regulatory departments to draw lessons and to be better prepared for possible chaos in the financial markets. After the head of government voluntarily communicated with the market, China’s stock and money markets all responded positively in the first week of trading in the Year of the Monkey, and jitters about the Chinese financial market were eased and are on the wane.
On Feb. 15, when the market resumed after the weeklong holiday, the yuan rallied on the onshore market. The onshore exchange rate of the yuan against the dollar performed strong on the day, up by 1.24% or the highest closing rate in 2016, recording the biggest single-day appreciation since the exchange rate reforms in 2005. On the offshore market, the yuan was also gaining. In the ensuing days, the exchange rate of the yuan against the dollar, on both onshore and offshore markets, hovered around 6.5. Market confidence in the yuan grew stronger. The stock market also began to stabilize, with the Shanghai Composite Index holding at around 2,800 points. This meant that the Chinese government has the resolution and capability to ward off international speculators and to reverse the current expectations for the devaluation of the yuan, and it also marked a new stage of self-correction and self-restoration for the Chinese equities market.
The communication between the head of the Chinese government and the market conveyed new messages.
First, the premier this time urged the regulatory departments to draw lessons, and this was something rarely seen. In the past, all policies implemented by the government were considered right, and no one or department was ever required to assess in self-examination and reflection the effects of the policy implementations or to take responsibility. This time, when the premier asked competent departments to earnestly draw lessons, it implied that somebody would have to assume the responsibility, and it is expected that a leadership reshuffle in the financial regulatory departments will be imminent. (The first leadership change in the financial industry already started. On February 20, Xiao Gang was removed from the post of chairman of the China Securities Regulatory Commission, and his replacement is Liu Shiyu, chairman of Agricultural Bank of China).
Second, the government has a clear-cut attitude towards the current situation of the economy and financial markets. Since the second half of 2015, the continuing depreciation of the yuan has been the most-watched issue in the market, and central bank Governor Zhou Xiaochuan responded to this concern, clearly and loudly. He said it is still highly uncertain to judge whether or not the yuan has been really stabilized, because the current global financial markets still face uncertainties. Opinions among central banks of all countries are very much divided in the face of such uncertainties. The market always pins its hope on some authoritative figures to speak up so as to turn uncertainty into something certain, but in reality, market uncertainty is always existing and objective, and explanations by any authoritative officials could not dispel or eradicate it. It is the case for the Chinese central bank, and the central banks of other countries are no exception. Therefore, whether or not the exchange rate of the yuan could be stabilized in the future hinges on changes in the market situations, not solely on policies of the central bank. If the growth prospects of the economy are not encouraging, the yuan would also face risks of devaluation. In other words, the yuan depreciation is the natural result of the market, and is not a big deal.
Also, in the eyes of Governor Zhou Xiaochuan, if the central bank offers definite forecasts, the market expectations would easily become very solid or even rigid. In such scenarios, if the expectations could not be fully realized in the end, it would be highly probable that the market would then misinterpret it. This has been proven by the developments of the foreign exchange market since reforms in the yuan exchange rate were adopted in August 2015. Therefore, openness and transparency in central bank’s foreign exchange policies, which are always highly advocated by the international markets, seem not to be so applicable in the Chinese market, because China’s foreign exchange policies for the yuan could easily be manipulated by global market speculators.
I believe market expectation is the basic decisive factor for the exchange rate of the yuan. If expectations could not be appropriately managed, it could easily land the market at a loss and in turn give an opportunity to short sellers. Therefore, expectation management is key to stability of the yuan. The central bank should give priority to the offshore yuan market, because this is not only a highly free and liberalized market, but also an important venue where international speculators would try to attack or manipulate the exchange rate of the yuan.
Governor Zhou Xiaochuan said that none of foreign-exchange reserves, current account or speculation was the core factor leading to its volatility. These factors have a short-term impact — the real, important variable with an impact on the yuan exchange rate is the shift in the formation of the exchange-rate system, for instance, a dollar-pegged fixed exchange-rate system, a system with reference to a basket of currencies or an international consultation system. In the short term, China will not choose any of the three as the standard for its exchange rate for the coming 10 years. In other words, the choice and shift of the exchange-rate formation systems will be a priority for the central bank in its future work, and this should also be the most effective way to counter international speculators.
It is apparent that the government has the resolution and capability in rehabilitating the current financial market. The central bank is adopting various measures to stabilize the exchange rate of the yuan, but market uncertainty and shifts in the exchange-rate formation systems will continue to disturb the stability of the yuan. The market should not worry too much about it.