The yuan could fall by 5% in 2017, and anything more than that will result in greater capital outflows, former People’s Bank of China (PBOC) adviser Li Daokui said.
The PBOC could spend an additional US$200 billion to US$300 billion to achieve its goal to control currency moves, Li, who now teaches at the Tsinghua University, told the Reuters Global Markets Forum on the sidelines of the World Economic Forum.
Li also said he expected growth to be the top priority for the Chinese government, over reforms, this year.
The following are edited excerpts from the conversation.
After three consecutive years of decline for the yuan, at what level do you think matters might get out of hand for the PBOC?
I have a benchmark of five percent depreciation, which will be the 7.35 yuan to the dollar. Anything bigger than five percent will trigger more capital outflows. Five percent is the spread between a Chinese low-risk rate and that of the U.S. dollar.
The US$1 trillion fall in PBOC’s forex reserves since July 2014 implies heavy action by the PBOC. How much of its coffers is the PBOC willing to give up to control currency moves?
Both offshore and onshore markets will be under intervention. If the PBOC does it properly, another US$200 billion to US$300 billion drop in the reserves will achieve the goal.
What is your view on recent measures to curb capital flight?
So far, 80% of capital outflow is by corporates. Thus, I expect the PBOC to sharpen its teeth on fake imports, which account for 60% of corporate-initiated capital outflow. I do not expect a lot of measures on household exchange for the USD (US dollar).
In recent statements, the PBOC has explicitly targeted bitcoin. What is your view?
The PBOC is worried about crypto-currency becoming rampant, and therefore become a way of bypassing capital control (since) bitcoin can freely travel across borders.
Would you expect China to tolerate slower economic growth in order to push through some “painful” reforms this year?
The central government or the top leaders would do so. However, this is the year of the Party Congress. So that local officials are competing for promotions and GDP growth is more visible than progress of reform. Therefore, local officials still will push for growth. That is, the final outcome is that growth will be a top priority.
On reforms, I expect (a) faster pace after the 19th Party Congress.
Do you expect the PBOC to tighten policy this year to put the brakes on flush credit conditions? Will it raise interest rates if inflation climbs higher?
Raising the interest rate is unlikely since corporations are crying for lower financing costs. But the PBOC will carefully watch credit growth while trying to maintain a certain level of total social financing. (A comfortable level on credit growth for the PBOC would be) no more than a 12% year-on-year increase.
Do you expect a trade war to erupt between China and the US?
I think Trump is more aggressive than that. Trump will implement targeted trade protectionist measures and high profile cases such as the ones against Chinese tires. He is a media-savvy president and he knows that WTO is not a hot topic in the US media. He will take things to his own hands. He will target Chinese goods competing with firms in Michigan, Wisconsin, etc. and impose super high tariffs. This will be a big Twitter event for him.
China, I think, will react in kind – US cars or planes will be the target. This will be a huge media war, but in terms of real impact on the economy, no big deal. We will have fun watching and analysing the trade war but no major economic impact on either side.
Can Trump really link the ‘one China’ policy to trade ties, as he has said? China says Taiwan is not negotiable. But what happens if Trump goes down that path? Do trade ties collapse?
On the China side, Taiwan is a top issue. For Trump, domestic economy is. Thus, both sides should have room to work out. Trump prides himself as a dealmaker. Let us see if this is the case. I am optimistic.
What do you think will be the PBOC’s biggest challenge for 2017?
Trump is the biggest challenge. In the first six months of 2017, international investors will have huge and unrealistic expectations of “Trump economics,” if I may call it: infrastructure, tax cuts, trade promotion. So that the USD will go higher and money will flow into the US, causing trouble for the RMB. But people will quickly find that the “Trump economics” takes time to work, e.g. tax cuts take time. Therefore after six months, the USD will come down. That is why I worry most for emerging market economies in the first six months.