The People’s Bank of China (PBoC) on Tuesday devalued the country’s currency, the RMB, by approximately 2%. Just weeks after China’s stock market regulators engineered a “recovery” in share prices by allowing mass-suspensions in trading and forcing state-owned financial institutions to buy and hold shares, the move stands as another stark reminder of the extensive controls that the government retains over China’s financial sector.
The gradual increase in the value of the RMB against the dollar since a hard peg was removed in 2005 led many to believe that China had finally decided to allow markets to drive the currency to its equilibrium value. Nothing could be farther from the truth.
Despite relinquishing the hard peg in 2005 and nominally broadening the daily “trading band” to 2% last year, the fact is that the PBoC has continued extensive interventions in currency markets on a daily basis. As a result, the true market value of the RMB is a matter of pure guesswork. Whether to assist the country’s manufacturers in exporting their way out of a crisis or to generate political support for the inclusion of the RMB in the IMF’s Special Drawing Rights, the RMB’s movements are more effectively analyzed by reading political tea leaves than by evaluating supply and demand.
Controls over the value of the currency are simply one tool in a broader system of financial repression in China, in which the state manipulates financial activity (whether bank lending, portfolio investment, foreign direct investment, or currency exchange, etc.) in pursuit of its strategic objectives. Over the last two decades in China, this has meant “subsidizing the production side of the economy and penalizing the consumption side of the economy,” leading to massive overcapacity in manufacturing sectors such as steel, aluminum, and solar energy equipment, as well as harmful trade imbalances at the expense of Chinese households and foreign industries.
Simply following the value of the RMB is thus not enough to determine whether China’s exchange rate is determined by market forces. Rather, imbalances and market distortions will persist as long as the government retains the tools of large-scale state intervention in financial markets.