China’s re­spon­si­bil­ity is no longer strictly lo­cal

The Pak Banker - - OPINION - Mo­hamed A. El-Erian

THE re­cent de­cline in China's cur­rency, the ren­minbi, which has fu­elled tur­moil in Chi­nese stock mar­kets and drove the govern­ment to sus­pend trad­ing twice last week, high­lights a ma­jor chal­lenge fac­ing the coun­try: how to bal­ance its do­mes­tic and in­ter­na­tional eco­nomic obli­ga­tions. The ap­proach the au­thor­i­ties take will have a ma­jor im­pact on the well­be­ing of the global econ­omy.

The 2008 global fi­nan­cial cri­sis, cou­pled with the dis­ap­point­ing re­cov­ery in the ad­vanced economies that fol­lowed, in­jected a new ur­gency into China's ef­forts to shift its growth model from one based on in­vest­ment and ex­ter­nal de­mand to one un­der­pinned by do­mes­tic con­sump­tion. Nav­i­gat­ing such a struc­tural tran­si­tion with­out caus­ing a sharp de­cline in eco­nomic growth would be dif­fi­cult for any coun­try. The chal­lenge is even greater for a coun­try as large and com­plex as China, es­pe­cially given to­day's en­vi­ron­ment of slug­gish global growth.

For years, China's govern­ment sought to broaden equity own­er­ship, thereby pro­vid­ing more Chi­nese cit­i­zens with a stake in a suc­cess­ful tran­si­tion to a mar­ket econ­omy. But, like the US' ef­fort to ex­pand home own­er­ship in the years pre­ced­ing the 2008 cri­sis, Chi­nese poli­cies went too far, cre­at­ing a fi­nan­cially un­sus­tain­able sit­u­a­tion that im­plied the pos­si­bil­ity of ma­jor price de­clines and dis­lo­ca­tions.

As a re­sult, the ad­just­ment chal­lenge has grown dra­mat­i­cally. With Chi­nese com­pa­nies no longer able to sell a rapidly in­creas­ing vol­ume of prod­ucts abroad and sup­port fur­ther ex­pan­sion of pro­duc­tive ca­pac­ity, the econ­omy has lost some im­por­tant growth, em­ploy- ment, and wage en­gines. The re­sult­ing eco­nomic slow­down has un­der­mined the govern­ment's ca­pac­ity to main­tain in­flated as­set prices and avoid pock­ets of credit dis­tress.

In an ef­fort to limit the detri­men­tal im­pact of all this on cit­i­zens' well­be­ing, Chi­nese of­fi­cials have been guid­ing the cur­rency lower. A sur­prise de­val­u­a­tion last Au­gust has been fol­lowed by a num­ber of lower daily fixes in the on­shore ex­change rate, all in­tended to make Chi­nese goods more at­trac­tive abroad, while ac­cel­er­at­ing im­port sub­sti­tu­tion at home.The ren­minbi has de­pre­ci­ated even more in the off­shore mar­ket.China's cur­rency de­val­u­a­tions are con­sis­tent with a broader trend among both emerg­ing and ad­vanced economies in re­cent years. Soon af­ter the global fi­nan­cial cri­sis, the US re­lied heav­ily on ex­pan­sion­ary mon­e­tary pol­icy, char­ac­ter­ized by near-zero in­ter­est rates and large-scale as­set pur­chases, which weak­ened the dol­lar, thereby boost­ing ex­ports.

More re­cently, the Euro­pean Cen­tral Bank has adopted a sim­i­lar ap­proach, guid­ing the euro down­ward in an ef­fort to boost do­mes­tic ac­tiv­ity. But in pur­su­ing its do­mes­tic ob­jec­tives, China risks in­ad­ver­tently am­plify­ing global fi­nan­cial in­sta­bil­ity. Specif­i­cally, mar­kets worry that ren­minbi de­val­u­a­tion could "steal" growth from other coun­tries, in­clud­ing those that have far more for­eign debt and far less ro­bust fi­nan­cial cush­ions than China, which main­tains am­ple in­ter­na­tional re­serves.

This con­cern speaks to the even more chal­leng­ing bal­anc­ing act that China must per- form as it seeks to play the role in global eco­nomic gov­er­nance that its eco­nomic weight war­rants. Af­ter all, China is now the world's se­cond-largest econ­omy (and, by some non­mar­ket mea­sures, the largest).

And, in­deed, China has lately been show­ing greater in­ter­est in grad­u­ally in­ter­na­tion­al­iz­ing its fi­nan­cial sys­tem. No­tably, it re­cently suc­ceeded in per­suad­ing the In­ter­na­tional Mon­e­tary Fund to add the ren­minbi to the bas­ket of cur­ren­cies that de­ter­mines the value of the Spe­cial Draw­ing Right, the unit the IMF uses in deal­ing with its 188 mem­ber coun­tries. That step - which places the ren­minbi on par with the ma­jor global cur­ren­cies (the US dol­lar, the euro, the Bri­tish pound, and the Ja­panese yen) - will en­hance pub­lic- and pri­vate-sec­tor ac­cep­tance of China's cur­rency in the in­ter­na­tional mon­e­tary sys­tem.

At the same time, it cre­ated the ex­pec­ta­tion - though not the obli­ga­tion - that China will re­frain from ag­gra­vat­ing global fi­nan­cial in­sta­bil­ity. There will come a time when China's do­mes­tic and in­ter­na­tional re­spon­si­bil­i­ties will again be rel­a­tively well aligned. But that time is not now; and, given the coun­try's tricky on­go­ing struc­tural tran­si­tion, it prob­a­bly will not come any­time soon. In the mean­time, it seems likely that China will con­tinue to feel com­pelled to place its do­mes­tic obli­ga­tions first, but in a nu­anced way aimed at avoid­ing large dis­rup­tive tip­ping points for the global econ­omy.

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