Fed Rate Hike Bodes Ill for China Economy
(Beijing) — The U.S. Federal Reserve's interest rate hike and its suggestion that it will accelerate such moves in the coming years have cast a shadow on prospects for the Chinese economy and are expected to prompt Beijing to take further measures to curb capital outflows.
The Fed on Wednesday decided to raise the federal funds target rate by a quarter percentage point to a range of 0.5% to 0.75%.
The announcement sent the central parity rate of the yuan, set by the People's Bank of China, to 6.9289 to the dollar on Thursday, its weakest since June 2008.
Analysts expect the yuan to be under continued pressure to depreciate, and Chinese policy makers, who are grappling with the problem of money fleeing the country, may move to further step up capital controls.
"Depreciation of the yuan will likely continue," Societe Generale economist Claire Huang told Caixin.
"Policymakers will tighten capital controls further, in particular on residential outflows (such as) outward direct investment, resident (individual) banking flows, etc., which were the main source of China's capital outflows," she said.
Beijing has taken a series of measures to stem capital flight as the yuan has weakened, including placing more restrictions on overseas investment by Chinese companies that were tempted to buy more dollar assets. This resulted in stronger demand for foreign exchange and reinforced the yuan's depreciation.
China has also been shedding holdings of U.S. Treasury bonds to support the yuan's value. The stockpile declined for the fifth consecutive month in October to $1.116 trillion, the lowest since July 2010, according to latest data from the U.S. Treasury Department and Wind.
"Overly fast yuan depreciation will hammer market confidence and exacerbate capital outflow," said Rong Jing, a Beijing-based economist with BNP Paribus.
When that happens, the central bank will "definitely intervene to some extent," she said.
In addition to setting more limits on money outflows, China may encourage foreign investors to invest in the domestic market by embarking on a unilateral capital account opening to liberalize cash inflows, Huang added.
Federal Reserve Chairwoman Janet Yellen suggested on Wednesday that more aggressive hikes are possible over the years to come, saying the median projection for the rate has risen from previous estimates in Sept. to 1.4% at the end of next year, 2.1% as of the end of 2018 and 2.9% by the end of 2019.
The Fed's tightening stance will affect the Chinese economy "negatively" and pose "a big challenge" for Beijing, which is walking a fine line between supporting the yuan's rate and boosting slowing growth, analysts said.
The continued strengthening of the dollar may force the Chinese government to sell more dollars and purchase the yuan, which would strain domestic liquidity.
Meanwhile, actual interest rates in China, particularly in the bond and money markets, have gone up as yields of U.S. bonds have climbed since the election of Donald Trump as president. Trump has promised tax cuts and more spending to spur growth.
That is because China's capital account is not completely shut from the outside world while its exchange rate is not totally floatable. This created both conditions and incentives for Chinese investors to put their money abroad and forced domestic borrowers to raise their offer, Rong said.
However, neither tight liquidity nor higher interest rates bode well for the Chinese economy.
"We expect China's economic growth to be relatively sluggish next year. In that case, liquidity can't go tight and interest rates can't go too high," she said.
But "authorities will have to tolerate actual interest rates to rise if they can't let the yuan depreciate by large margins."
Xie Yaxuan, chief macroeconomic analyst at China Merchants Securities, also said the Fed's rate hike is "generally negative."
"The Chinese government will continue to take effort to balance capital inflows and outflows. It will certainly crack down on the small number of speculative flows," he said.
The story was updated with U.S. Treasury's Thursday release for October's major foreign holdings of Treasury securities.
Contact reporters Chen Na (firstname.lastname@example.org) and Fran Wang (email@example.com)
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