« Where is the will, there is the way » said, a long time ago, Lao-Tseu. The reading of the project of the 13th Plan, being discussed this week-end in Beijing at the People Assembly, shows that this principle is still present. Guidelines related to China monetary policy which are included in the document, give a light which it is necessary to decode in order to understand the path the country will follow and its consequences on international economic and financial exchanges.

The Yuan internationalization strategy, initiated in 2009, will go further. Its convertibility is definitely a clear objective as its use in China foreign transactions. Restrictions to capital flows in both directions will be progressively lift, financial markets access, for shares and bonds, will be facilitated and foreign investments in some high-tech sectors and in technologies related to energy-saving processes will be encouraged. The line is now clear, even if, as we said, Chinese authorities don’t have a sufficient experience of financial markets reactions. But we have also to admit that they learn quickly. They will have to carry on and manage often contradictory priorities, which, during the previous months, provoked bumps the country did not accustom us. But Beijing central objective, the economic, then political, stability, is not under threat.

China has started its economic transition after the “Glorious Thirties” which followed, at the beginning of the Eighties, the reforms launched by Deng Xiaoping. The economic model, based on low-cost sub-contracting for the world industry and the delocalization of western and Japanese firms, has reached its limits. The rise of the standard of living of a growing share of the population, due to wage increases, especially in the south, which was the birthplace of the industrial take-off of the country, has affected production costs. In the same time, world demand was slowing. This strategy didn’t allow anymore the country to reach the high growth rate, which permitted to take out from the extreme poverty populations which were still confronted with. In the same time, millions of young Chinese, educated in universities, got the appropriated qualifications to make possible the emergence of firms able to compete directly with great multinational companies. China, to pass this next step, had to achieve, in the same time, a double reorientation of its economic model: to transfer growth engine to domestic demand and to encourage the creation of major industrials groups able to offer to young graduate Chinese the jobs they could aspire to. But for that, China could not anymore stay indifferent to the evolution of its exchange rate.

The decision, taken at the worst moment, in august 2015, to modify the mechanism through which the exchange rate of the Yuan was fixed, was the answer to these new constraints. For five years, Beijing had chosen a system with a rather stable parity with the US dollar. Everything was OK when the dollar was going down. That had no negative consequences on trade. And that did not affect financial transactions since there level was low. The will to give a more important role to the Yuan on the world financial markets would naturally make Chinese economy more sensitive to foreign environment. This is what happened with the divergent monetary policies of the Fed and the ECB which provoked a 20% rise against the euro, and with the fall of oil and raw material prices which sent emergent countries currencies plummeting, especially in Brazil and Russia. Keeping a fixed parity with the dollar was equivalent to accept a reevaluation of the Yuan against all these currencies which was quite incompatible with the economic strategy of the country and the reorientation which was expected. This situation presented a heavier risk after 2015 summer since the Fed, had announced, in veiled terms, a more restrictive monetary policy synonym of a further appreciation of the dollar. Another reevaluation of the Chinese currency when the economy was slowing and when it was still dependant of its foreign exchanges was, of course, nonsense. But that’s not all.  

The fixed parity with the dollar and the management of this link in a world of floating rates was denounced by the IMF and represented a major obstacle to the recognition of a reserve currency status for the Yuan and its inclusion in the basket of currencies used to calculate SDR parities. So Beijing had a second good reason to break itself of this fixed link and to adopt new criteria for its interventions on the Yuan market. But monetary authorities did not know how to prepare financial markets to this move and, especially, to explain it. So investors thought that China, due to its real or supposed difficulties, was preparing a currency war. In fact, the new mechanism provoked very modest modifications of the Yuan exchange rate. And the current contraction of both imports ans exports is mainly the consequence of the fall of the prices of imported raw materials and exported basic industrial products, as steel.

The country was not at the end of its difficulties since the next step was the convertibility of its currency, objective which has been confirmed in the 13th Plan. But its implementation supposed to liberalize capital flows. The simultaneity of the currency regime modification and an even limited change in the regulation of foreign transactions has provoked reactions Chinese authorities had not, once again, expected and anticipated but which were easily foreseeable. Chinese and foreign firms, which had dollar liabilities ran to reimburse them and sold Yuans to buy the dollars they needed. Households in China who had the authorization to detain dollar assets, started to convert their savings into dollars to take advantage of its rise. Outside of China, and especially in Hong Kong, those who had Yuans, with the support of Chinese authorities who thought that the possession of assets in the Chinese currency contributed to their objective of transforming the Yuan into an international currency, also started to sell it. People Bank of China had to make interventions on the exchanges markets to stabilize rates and utilized a part of its huge reserves, evaluated at that time near 4000billions dollars, for about 100billions each month. Financial markets interpreted these figures as a new negative signal from the Chinese economy. And they found another source of worry after the emergent countries crisis, the stagnation of both eurozone and Japan, along with the doubts about the American economic rebound.

So, Beijing had underestimated the challenge created by these reforms: to achieve in the same time the rebalancing of the economy, the modification of the currency management and the liberalization of capital flows was difficult without generating turbulences. They came up but the course, confirmed in the 13rd Plan project, has been preserved and financial markets are now stabilizing. Where is the will, there is the way…