Market players are starting to realise that policymakers will have to throw in the towel on the 7% growth target. For some (or even many), the official figures have overstated the growth backdrop for some time and GDP growth is likely closer to 5%–6% than 7%.
As the downside risks to growth and inflation increase, the past few months have seen China’s political leadership remove the flexibility that agents such as the PBoC had enjoyed in setting policy. This has created volatile and messy outcomes for financial markets, especially following the intervention in the equity market and the unexpected adjustment to its FX policy stance.
For broader EM countries, the ripples have come through lower commodity prices, equity market volatility and perceptions that Beijing’s now favours CNY weakness.
While intervention from Chinese policymakers is understandable given their desire to limit volatility, other EM countries are not engaged in steps that limit their equity and FX markets from adjusting.
Once the market, especially FX, have adjusted, the big FX reserves stockpiles that were built up after the 1997/98 Asia crisis will come in handy to foster stability.
A more flexible FX policy should help to calm things down rather than prolonging the battle and creating a basis for speculative attacks, as in 1997/98. In a sense, free-floating exchange rates are doing their job.
Volatility is unavoidable as China adjusts, but the country understands its responsibility in limiting the fallout. This is why it has limited CNY/CNH weakness after the and will not let growth expectations fall too sharply. Even though various stimulus have failed to gain traction, Beijing will still keep monetary and fiscal stimulus targeted.
Growth slightly below 7% might be acceptable for this year but not below 6.5% (the IMF’s forecast is 6.8%).
Limiting CNY/CNH weakness has seen most Asian FX pairs weaken by about 3% since August 11 – a relatively small amount. Outliers continue to be those with other domestic factors at play, such as MYR (corruption scandal & BNM’s failed intervention) and the VND (devaluation, such as Wednesday’s, is its main monetary policy tool).
