China capitulates after losing $400bn supporting its currency, share market

An investor monitors share prices during morning trading inside a brokerage at the financial Central district in Hong Kong, China August 25, 2015. China's major stock indexes slumped more than 6 percent to 8-month lows in early trade on Tuesday before paring losses, after a catastrophic Monday that destabilised financial markets around the world. REUTERS/Bobby Yip
An investor monitors share prices during morning trading inside a brokerage at the financial Central district in Hong Kong, China August 25, 2015. China’s major stock indexes slumped more than 6 percent to 8-month lows in early trade on Tuesday before paring losses, after a catastrophic Monday that destabilised financial markets around the world. REUTERS/Bobby Yip

After spending about $200bn buying shares to prop up slumping equity prices over the past seven weeks, Beijing capitulated to market forces on Monday by choosing not to intervene as the benchmark Shanghai Composite Index fell 8.5 per cent.

The fall was the worst since February 2007. But unlike on most other days since the government launched an unprecedented effort to reverse plunging equities last month, the “national team” of state-owned stock buyers did not jump in to support the market.

Beijing’s leaders appear to have belatedly decided it is too expensive and ultimately futile to fight gravity in the equity market, especially as the government is now intervening separately on a massive scale to stop its currency from devaluing further.

Since the People’s Bank of China devalued its currency and introduced a new “market-oriented” foreign exchange price-setting mechanism on August 11, it has had to spend as much as $200bn of the country’s foreign exchange reserves to prevent the renminbi from falling more than it wants, according to people familiar with the central bank and its market interventions.

That was more money than the PBoC had spent over the past two years to keep its currency in the desired range against the dollar, these people said.

The scale of the intervention in both equity and currency markets has led many to question whether the Chinese authorities are in control of the situation or whether they have made a series of policy blunders.

“The problem they have now is that they’ve spent as much as $400bn supporting the currency and stock market and they are now worse off than when they started,” said one person with close ties to the PBoC. “I think they got overconfident and underestimated how strong the global reaction would be to the devaluation.”

After initially allowing the renminbi to devalue by about 4.5 per cent in the first few days after August 11, the central bank seems to have effectively re-pegged it to the US dollar since then.

But that has been achieved only through intervention in currency markets, as government traders on the PBoC’s open market desk intervene in the onshore market in the last hour of trading to buy renminbi and sell dollars to the tune of about $10bn a day.

Even more significant is the fact that the PBoC has for the first time started to intervene on a significant scale in offshore currency markets in Hong Kong and London, according to people who track the central bank’s onshore and offshore activities.

“In the past we knew they fiddled a little bit with the [offshore-traded renminbi, known as the CNH] but since the devaluation we can see they are very clearly present in the offshore market,” one of these people said.

China has the world’s largest foreign exchange reserves, with $3.65tn at the end of July, but it is now eating into those reserves at almost the same pace as it accumulated them in the past.

After China’s benchmark stock market index fell almost 12 per cent last week, most analysts and economists had expected the government to announce fresh monetary policy loosening over the weekend, most likely by reducing the proportion of deposits that banks need to hold in reserve.

That is still expected in the coming weeks, according to Yu Yongding and Li Daokui, two former academic members of the PBoC’s Monetary Policy Committee, even though it will complicate the central bank’s job further by adding to pressure on the renminbi to depreciate.

“People all over the world are now watching China’s economy and China’s monetary policy is only second to the US Fed [in global importance],” said Mr Li, an economist at the Center for China in the World Economy atTsinghua University. “I expect further [stimulatory] measures in the coming days and weeks. By doing something at this juncture the Chinese central bank is not only supporting the Chinese economy but also emerging markets.”

With so much focus on China and the turmoil it is causing in international markets, some global investors have been baffled by the customary opacity of the country’s authoritarian leaders.

Zhou Xiaochuan, China’s central bank governor, has not been seen in public since the devaluation on August 11, and other senior Communist party leaders have barely referred to the plunging markets in their public statements in recent weeks.

In an article in Chinese state media on Monday, Premier Li Keqiang exhorted senior party officials to do more to develop China’s 3D printing industry but said nothing about the turmoil in markets or a gathering slowdown in the wider economy.

(c) 2015 The Financial Times Ltd.

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