BEIJING—Behind closed doors in March, some of China’s most prominent economists and bankers bluntly asked the People’s Bank of China to stop fighting the financial markets and let the value of the nation’s currency fall.
They got nowhere. “The primary task is to maintain stability,” said one central-bank official, according to previously undisclosed minutes of the meeting reviewed by The Wall Street Journal.
The meeting left little doubt China’s top leaders have lost interest in a major policy shift announced in a surprise move just nine months ago. In August 2015, the PBOC said it would make the yuan’s value more market-based, an important step in liberalizing the world’s second-largest economy.
In reality, though, the yuan’s daily exchange rate is now back under tight government control, according to meeting minutes that detail private deliberations and interviews with Chinese officials and advisers who spoke with The Wall Street Journal about the country’s currency policy.
On Jan. 4, the central bank behind closed doors ditched the market-based mechanism, according to people close to the PBOC. The central bank hasn’t announced the reversal, but officials have essentially returned to the old way of adjusting the yuan’s daily value higher or lower based on whatever suits Beijing best.
The flip-flop is a sign of policy makers’ deepening wariness about how much money is fleeing China, a problem driven by its slowing economy. For now, at least, officials believe the benefits of freeing the yuan are outnumbered by the number of threats. Re-emphasizing the yuan’s stability would also bring a sigh of relief to trading partners who worried a weaker currency would boost Chinese exports at the expense of those produced elsewhere.
Freeing the yuan, the biggest overhaul of China’s currency policy in a decade, was meant to empower consumers and help invigorate the economy. The negative reaction, from financial markets world-wide and Chinese who sped their efforts to take money out of the country, was so jarring that the top leadership, headed by President Xi Jinping, began to have second thoughts.
At a heavily guarded conclave of senior Communist Party officials in December, Mr. Xi called China’s markets and regulatory system “immature” and said “the majority” of party officials hadn’t done enough to guide the economy toward more sustainable growth, according to people who attended the meeting.
To the central bank, there was only one possible interpretation: Step on the brakes.
Yi Gang, a deputy central-bank governor, said in April in Washington that “the market is still the No. 1 factor” in determining the yuan’s value.
Instead, people close to the PBOC said, the bank guides the daily direction of the currency by alternating between setting the yuan’s value against the dollar and a basket of currencies. The central bank’s press office didn’t respond to requests for comment.
Earlier this month, Beijing staged what appeared to be a publicity blitz aimed at reaffirming its overall economic reform intentions while keeping the yuan basically stable. That came after a wave of credit helped gross domestic product expand 6.7% in the first quarter, still the slowest pace in seven years. Much of the $1 trillion in new credit flowed into the housing market, spurring questions over the sustainability of China’s debt-fueled expansion and the leadership’s resolve to restructure the economy.
The People’s Daily, the Communist Party’s mouthpiece newspaper, published May 9 a lengthy article that cautioned against going back to old ways to stimulate growth.
People familiar with the matter said top economic advisers to Mr. Xi ordered up the article, which also stressed the need to keep the yuan “basically stable.” The information office of China’s State Council didn’t respond to requests for comment.
Mr. Xi, 62 years old, took power in late 2012 and has established himself as China’s most powerful leader in decades.
China’s economic policy was long the purview of the nation’s premier. That changed under Mr. Xi, who has concentrated controls in his own hands. At the same time, he has been dismayed that his decisions on structural overhauls haven’t been effectively implemented by the government led by Premier Li Keqiang, officials close to Mr. Xi say.
People who are sympathetic to Mr. Li say the premier is in a bind because his job duties also include hitting Mr. Xi’s economic growth targets. Those people say meeting the targets means the government has to dial back on closures of smokestack factories, freer capital flow and other changes.
The preference for stability in China’s currency policy rather than change reflects the jockeying that has begun as party officials look ahead to next year’s reshuffling at the top. A majority of the seats on the seven-member Politburo Standing Committee will open up. “No one wants to make mistakes at this juncture,” one senior Communist Party official says.
The retreat from making the yuan more market-based puts China’s central bank in the difficult position of having to battle continuing downward pressure on the currency, also known as the renminbi. Since the end of April, the yuan’s value has dropped three weeks in a row.
Keeping the currency stable comes at the expense of China’s foreign-exchange reserves and restrains the PBOC’s ability to protect the economy.
China had $3.22 trillion in currency reserves in April, down from nearly $4 trillion in June 2014. The U.S. Treasury Department estimates Beijing sold more than $480 billion in foreign-currency assets from August through March to support the yuan.
The money flow out of China by companies and individuals slowed to $28 billion in April from more than $100 billion in December and January, according to estimates from UBS Group AG. Chinese authorities have stepped up controls aimed at discouraging outflows.
“China’s underlying depreciation pressures remain unaddressed, as restructuring and reform have so far advanced in fits and starts,” says Harrison Hu, China economist at Royal Bank of Scotland. “This leaves the risk of jolts to financial markets open.”
Currency policy has been one of China’s most politically charged economic issues. Those who are pushing the central bank to allow the market to take the yuan lower, as the PBOC indicated it would do in August, include the Commerce Ministry, which watches out for exporters helped by a weak yuan.
Such companies have found allies in economists at the government think tank China Academy of Social Sciences, who argue the yuan has become overvalued as the economic slump drives capital to leave China.
On the other side are China’s giant state firms, which are generally ill-equipped to deal with market swings and hold large amounts of debt denominated in U.S. dollars. As a result, they prefer that the yuan stay close to the dollar.
The central bank has been a voice for a freer yuan as a way to inject greater discipline into the economy. It ultimately answers to Mr. Xi, who initially promised to give market forces a “decisive” role in the economy when he took power.
The Chinese president set out to make the yuan more viable internationally, and one of his top economic priorities for 2015 was to get the International Monetary Fund to include the yuan in its basket of reserve currencies.
Achieving the milestone would show China’s growing economic clout. The nation represents about 15% of the world’s output, nearly triple what it was a decade ago.
Last year, Zhou Xiaochuan, China’s longtime central-bank governor and a champion of market-oriented policies, saw an opportunity to accomplish two goals at once: give the market bigger sway in setting the yuan’s value, which the IMF required, and let some air out of the currency.
It had become increasingly costly for the PBOC to keep the yuan close to the dollar. “It is the time to change the currency policy,” Mr. Zhou said in March 2015.
In August, the PBOC said it would base the yuan’s fix, or the value set each day by the central bank, on the previous day’s market close. Until then, the value had been entirely determined by the central bank itself. The PBOC paired the policy shift with a devaluation of almost 2%.
The announcement came with few details and scant explanation. Investors saw the move as a suggestion that China’s economy was in such bad shape that the central bank was taking extraordinary steps to help Chinese exporters. The yuan plummeted, and countries from Kazakhstan to Vietnam to Pakistan quickly devalued their own currencies.
The panicked response upset Chinese leaders. Within a day or two, a group on economic matters led by Mr. Xi instructed the central bank to stabilize the yuan, which it did by dipping further into its foreign-exchange reserves.
As early autumn winds dissipated the summer heat in Beijing, the temperature was rising in the southern part of the walled Zhongnanhai compound where Mr. Xi works. The leader didn’t like what he saw.
The attempt to make the yuan more market-driven, described by one economic official as “depreciation disguised as reform,” was turning into a major cause of market uncertainty and capital outflows.
Chinese stocks tumbled nearly 25% in two weeks following the currency move, and the country’s currency reserves fell $93.9 billion in August.
In November, the IMF gave its nod to the yuan’s inclusion with its reserve currencies. There was a sense of “mission accomplished” among many Chinese leaders, and the central bank’s commitment to its new “fix” mechanism started to waver, according to the people close to the PBOC.
At the party’s year-end economic conference in December, Mr. Xi indicated that the turmoil in China’s financial markets had made him think twice about hurrying in reforms, according to the officials with knowledge of the meeting.
Mr. Xi talked about the need to guard against risks and said China’s international standing depended on “whether we can mind our own business well.” About two weeks later, the PBOC abandoned the market-based mechanism.
Eswar Prasad, a China scholar at Cornell University and the IMF’s former top official in China, says the “uneven and haphazard approach to making the exchange rate more flexible highlights the tensions between the government’s desire to free up markets and its tendency to override markets when they do not produce the results it wants.”
The powerful State-Owned Assets Supervision and Administration Commission was instrumental in convincing Chinese leaders to backtrack. The more the yuan is allowed to weaken, officials said, the more expensive it will be for already struggling state firms to service their loans.
A 3% depreciation of the yuan could add $25.6 billion to Chinese companies’ annual interest payments on dollar debts, according to estimates by analysts at BNP Paribas.
“The exchange-rate policy is being hijacked by state-owned enterprises, whose words carry a lot of weight with the leadership,” an official close to the state agency says. Companies with high dollar-debt exposure include China’s three national airlines and its largest shipping firm, China Cosco Holdings Co.
In the past few weeks, the strengthening dollar has renewed pressure to steady the yuan. The yuan is down 0.9% since the end of April, erasing the currency’s gain of 1% during the previous two months.
In late February, some central-bank officials expressed frustration they had to retreat from yuan liberalization because of pressure from the state sector. The comments were made during a meeting in Shanghai with economists, bankers and representatives from state-owned and private companies.
Central-bank officials defended the interventions again during the March closed-door meeting in Beijing, saying ordinary Chinese might rush to dump yuan for foreign currencies if the yuan is allowed to weaken too much.
The head of one of China’s largest brokerages expressed dismay that all the emphasis was on stability. The chief economist at one of China’s top banks asked why the PBOC had been so quick to prop up the yuan. An overvalued currency could drag down the economy further by forcing Chinese manufacturers to cut prices and lower wages, the economist argued.
“If we’re bent on stabilizing the yuan above what it’s really worth, how will that affect the economy?” the economist asked. The frustration put PBOC officials on the defensive. “The comments all of you made are correct,” said one official. At least for now, though, he added, the market’s influence on the yuan would be decided by Beijing.http://www.wsj.com/articles/china-preferring-stability-to-free-markets-loses-resolve-to-revamp-currency-1464022378
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