China: Forces of Movement and Forces of Order
In every organization, including the Chinese Communist Party, there are forces of movement and forces of order. The forces of movement have moved into ascendancy in China and this was signaled by establishment of the special economic zone in Shanghai and the program emerging from recent Third Plenary Session. However, the uncertainty over implementation kept domestic and foreign investors cautious.
Yesterday's announcement by the People's Bank of China will help reassure investors and the pace of implementation may be more aggressive than anticipated. Financial reforms will be rolled out in the next three months and "most" of the reforms will be implemented within a year. Moreover, these reforms may be duplicated in other special economic zones.
That said, it is still unclear whether "most" reforms include liberalization of capital flows. For example, individuals employed in the zone are supposed to be allowed to buy foreign assets easier. It is to allow foreign companies operating in the zone to buy Chinese assets. This could dramatically alter Chinese capital flows, if allowed to the fullest extent.
It is also true that of the various institutional stakeholders in China, the PBOC is typically among the strongest advocates of liberalization, though its overall influence is debatable. Nevertheless, it matches the signal we picked up from our recent discussions with Chinese officials. The tone of much of the off-the-record comments reflect a awareness that the forces of order have subverted and/or blocked reforms. At the same time, these officials seemed unusually confident the forces of reform have the upper hand.
Of course, the forces of order are not defeated and have to be co-opted. The quid pro quo may be over politics and security, which the forces of reform will have to respect vigorously, which may be in part, what the escalation of tensions over the disputed islands reflect. Nor are Chinese officials, including the forces of reform, willing to discuss openly the contradiction between the modernizing economy and the continued rise of the middle class on one hand and the arcane and inflexible political system on the other.
The forces of movement are aware of the track record. Of the 124 emerging market countries that sustained 5% or more growth for a 10-year period since 1980, 52% were representative governments and 48% were authoritarian governments. The type of political regime is a poor predictor of the ability to sustain growth.
Both the forces of movement and order are celebrating this week's news from SWIFT, that the renminbi has surpassed the euro in global trade finance, with an 8.66% share of letters of credit and collection last month (euro share 6.64%). The US dollar share is 84.96%. At the start of last year, the RMB's shares was a little less than 2%. An estimated 20% of China's trade is now invoiced in RMB compared with 1 % four years ago. Some industry forecasts suggest it can reach 33% in the coming couple of years.
SWIFT says the RMB is the 12th most used currency for transactions on its global payments system in October. Its growth rate of 1.5% on the month was less than the 4.6% overall growth. This means that the RMB's market share slipped to 0.84% from 0.86%. According to BIS figures, daily RMB turnover averaged $120 bln in April and nearly 4-fold increase since 2010 and places in into the ninth position overall.
The Deputy Governor of the PBOC said recently (Nov 20) that it is no longer in the national interest to continue accumulating foreign exchange reserves, which stood at a little above $3.6 trillion at the end of Q3. However, this was not a policy indication as China appears to be still accumulating reserves. Moreover, while some pundits read this as a blow to the US, this has been the US Treasury position for a long time.
The announcement earlier today that bans Chinese banks from trading Bitcoins is perfectly consistent with the reformist agenda. There are no Bitcoin instruments, like notes or bonds. The Bitcoin is not backed by gold, silver or commodities. The apparent anonymity lends itself to money laundering and illegal capital movement. Just as the forces of movement embrace greater capital market liberalization, they have to vigorously clamp down on extra-legal forms.
The message was driven home by the fact that the decision to ban banks from trading Bitcoins was made jointly by five different government entities, including the PBOC, the Ministry of Industry and Information Technology, the China Banking Regulatory Commission, China Securities Regulatory Commission and China Insurance Regulatory Commission. Going forward virtual currency trading platforms will have to register with telecommunication authorities.
Lastly, we note that privately Chinese officials appear to be increasingly concerned about the surge in bond yields since mid-year. China's 10-year bond yield has risen about 120 bp since early July to almost 4.8% at the end of November. Like Japanese government bonds, though for different reasons, the vast majority of Chinese bonds are owned by domestic entities.
Domestic insurers, pension funds and commercial banks alone hold about 75% of the government's debt. We suggest three forces that have driven Chinese bond yields higher: increased supply, the rise in global yields and the rise in headline inflation from 2.1% in May to 3.2% in Oct.
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