The Decline Of Foreign Reserves And RMB Devaluation Will Form A Vicious Circle.

The more foreign reserves drop, the more worried the market will be.

With foreign reserves falling to a new low of three years, is it possible to let the renminbi depreciate once and for all?

China's central bank data showed that China's external reserves fell 512 billion 700 million dollars to $3 trillion and 330 billion in 2015, and the decline was up to $320 billion in August only in the five months (8-12 months) since the reform in August.

In December, a record amount of $107 billion 900 million was recorded.

How do we break this vicious cycle? Institutions including DBS bank believe that the central bank's choice includes allowing the yuan to float freely, enforce strict capital controls, or allow the renminbi to depreciate once and for all, but every option has risks.

DBS said allowing the yuan to float freely is more like a textbook solution:

There is no advantage in doing so.

First, foreign reserves will not be exhausted by defending the renminbi.

Second, the mechanism will help China regain some competitiveness, given that the trade weighted renminbi has appreciated substantially in most other currencies.

Third, the effectiveness of monetary policy can be maintained because intervention in foreign exchange markets has tightened the money supply, thereby counteracting the effectiveness of loose monetary policy.

The downside risk of the scheme is that no one knows how fast the renminbi will depreciate and how it will eventually fall.

It takes a lot of courage for policymakers to take this road.

The implementation of strict capital controls is not in line with China's goal of gradually opening capital account. Taking this step will be considered as a "backstop". Many analysts believe that China does not need to take this step for the time being.

China's regulators recently asked banks to conduct a rigorous review of the business and product trading background of the RMB pool and strictly control the net outflow of cross-border RMB capital pool business. The net outflow balance at any time point should not be greater than zero.

Prior to this, the central bank has adopted measures such as depositing the normal deposit reserve ratio within the offshore financial institutions to ease the pressure of net outflow of capital.

Then, is it desirable to let the renminbi depreciate once and for all? DBS bank said that if the depreciation rate is large enough, the depreciation expectation may be eliminated and capital controls need not be strengthened.

However, if moderate depreciation is needed, capital controls may be needed to deal with market or speculation.

However, the latter will mean the reversal of the internationalization of RMB, and it does not conform to the conditions for RMB to be included in the IMF basket of currencies (SDR).

Xu Gaoze, chief economist of Everbright Securities, believes that the one-off devaluation scheme will be the worst policy to control the RMB exchange rate.

First of all, no one knows how much Renminbi should depreciate.

The academic circles have done a lot of research on the exchange rate movement. The basic conclusion is that under the floating exchange rate system, all kinds of macro variables have little explanatory power on the trend of exchange rate, and the exchange rate changes show a very strong randomicity [1].

This means that any estimate of the so-called "equilibrium exchange rate" is inaccurate and there is a great error.

At present, the suggestion that all kinds of RMB should be devalued in the market is just a guess of some people's brains and can not be regarded as a serious basis for policy regulation.

Secondly, the free floating exchange rate tends to "overshoot" (overshooting), that is, the movement of the exchange rate in a certain direction will always pass first and then callback:

In short, it is to depreciate first, to overdo it, and to rise first.

This is the trend of many Asian currencies in the Asian financial crisis.

After the fall of the fixed exchange rate between the Thai baht and the US dollar in the 1997 year, the Thai baht first depreciated more than 50% in a few months and then appreciated more than 20%.

Similar trends can also be seen in currencies such as won, Malaysia and ringgit (chart 2).

Therefore, even if we really know the market equilibrium level of the RMB against the US dollar, the exchange rate will not remain stable once the value is depreciated to that position, and the depreciation pressure will continue to exist.

In addition to the above two points, the harm of a one-off depreciation to China's policy reputation and the disruption of market expectations must also be taken into account. Xu Gao pointed out:

RMB after "811 new exchange reform"

The rise is largely due to the expectation that the people's Bank of China will abandon its adherence to the RMB exchange rate, thus triggering the market's "false start" behavior against the people's Bank of China.

In recent months, senior leaders, including President Xi, clearly stated that "there is no foundation for long-term depreciation of the renminbi".

Moreover, as the reputation is impaired, the effectiveness of other policies in China will be greatly reduced, and the government's control over the economy will be greatly lost.

In Xu Gao's view, the best way to maintain the stability of the RMB exchange rate is "shock and awe":

At present, China's foreign exchange reserves are still sufficient.

By the end of 2015, our foreign reserves exceeded US $3 trillion and 300 billion enough to cover our country's imports for 20 months.

When the exchange rate of Thailand and South Korea fell in the 1997 year of the year, its reserves were only 6 times and 3 times the monthly imports of the two countries in the same period.

At present, China still has a large trade surplus, which is quite different from that of the Southeast Asian countries in the Asian financial crisis.

Sitting on so many foreign reserves, the renminbi

The pressure is getting stronger and stronger. The reason for this is that China's exchange rate regulator has already grasped the market's mentality.

The exchange rate regulator is being led by the market, and the exchange rate pricing power is taken away from the offshore market. The prospect of the exchange rate is not good.

If the policy makers can convey to the market the full determination of stabilizing the exchange rate of the RMB against the US dollar, instead of maintaining the stability of the "basket of currencies", and creating a trend of appreciation in a timely manner, the devaluation pressure of the renminbi will gradually disappear.

The key lies in the guidance of market expectations.

If regulators show no need to spend large quantities of external reserves to maintain

With a stable attitude, the exchange rate is easy to stabilize and the actual consumption will not be much.

On the contrary, it is difficult to stabilize the RMB exchange rate if it is afraid of the loss of foreign reserves and foreign reserves.

Perhaps the government itself needs a clearer goal to guide market expectations.

"Looking back on the macroeconomic trend and policy trend in recent years, it seems that we are not steadfast in one direction and the market is also in a long-term contradiction," wrote Qu Qing, chief bond analyst of Huachang securities in October last year.

"We think that the core issue is whether the government wants to do so or not."

First, there is no doubt that it is necessary to pform and emphasize growth.

Second, we hope that the renminbi will depreciate and that the renminbi will depreciate.

Third, we want both interest rate liberalization and interest rate liberalization.

The marketization of interest rate is an inevitable way to improve the development of financial system.