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  • Has China's central bank manipulated global trade?

    Publish Date: September 21, 2018

    China, the world's most populated country, has reached great heights in the global economic landscape. A $17 trillion economy today (as per the International Monetary Fund [IMF]), China has transformed itself. From the centrally planned closed economy of the 1970s, it has turned into a manufacturing and exporting hub.

    There is no doubt that China today is a trading powerhouse. In fact, it has often been cited as the gold standard for other emerging market economies, including India. But what if we told you that China's central bank has manipulated global trade? Yes, that is one of the conclusions we can draw. Read on to know why.

    Attracting capital flows

    Chinese economic liberalisation in the 1980s, under Deng Xiaoping, helped the economy attract massive amounts of capital into the country. This capital was by way of foreign direct investment (FDI) flows, foreign portfolio investment (FPI), and inflows through the Chinese banking system.

    Any economics professor will tell you that when a country attracts such massive inflows, it would automatically be running a current account deficit (CAD). A CAD is the measurement of a country’s trade, where the value of its imports is greater than the value of its exports. But China never ran a CAD! That is what is surprising.

    Also read: Rupee falling? No need to hit the panic button… yet

    Enter the dragon

    Any other nation with massive inflows would have run a CAD, but not China. This was because of the country’s central bank, which is called The People's Bank of China (PBOC).

    The Chinese central bank regularly intervened and bought US dollars while selling yuan (its local currency). By boosting the dollar, still one of the most powerful global currencies, the yuan was made to look weak. This activity helped China keep the yuan undervalued for years. By buying dollars and selling yuan, the country created an outflow of capital on its own!

    As a result of this activity, the capital account of China, which should ordinarily have been at a surplus, flipped to a deficit. Do remember that a capital account deficit causes the current account to turn into a surplus.

    Also read: 6 things to know about China currency devaluation

    Manipulation?

    If the Chinese central bank had not intervened to buy dollars during the 2001–2014 period, China would have run a CAD or a trade deficit. In other words, China would have been a net importer. This is the reverse of the 'net exporter' status that we normally associate with China.

    Between 2002 and 2014, China enjoyed a positive current account balance as a percentage of the gross domestic product (GDP). For instance, in 2008 when the global financial crisis took place, China reported a 10% current account balance as a percentage of GDP. But if its central bank had not bought dollars, that number would have been a negative 3%.

    Hence, through dollar purchases the PBOC ensured that China remained a net exporter and not a net importer. If these questionable activities had not taken place, the net impact on the yuan could have been quite positive. So, if the PBOC stayed out of the forex market, the Chinese currency could have been significantly stronger vis-à-vis the US dollar and other currencies.

    Also read: Emerging markets have taken a beating: All you need to know

    What a stronger yuan means

    A sharp rise in China’s yuan has many implications. Theorists say that a strong yuan might reduce the US trade deficit by a third. It could result in the creation of enough American jobs so that the unemployment rate falls.

    A stronger yuan could simply shift manufacturing to other low-cost producers. Do note that a weaker yuan makes Chinese goods more attractive in overseas markets, thus helping the country’s exports. When that forced 'weakness' goes away, the exports may not be so high.

    Also read: Contagion effect of China on world markets

    Cut to 2018

    China is reported to be using its currency to deal with the trade war. The strategy is to weaken the yuan so as to minimise the effect of President Donald Trump's trade tariffs on the Chinese economy.

    A weak yuan means a stronger dollar. That means the US tariffs could reduce the appeal of some American goods to Chinese consumers too.

    Many are saying that a weakening currency (yuan) may be one of the factors motivating Trump to announce that the US will now consider imposing 25% tariffs in place of the 10% tariffs previously proposed.

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