AJISS-Commentary
The Association of Japanese Institutes of Strategic Studies
IIPSRIPSInstitute for International

The Japan Institute ofResearch Institute for

Policy Studies

International Affairs

Peace and Security

Editorial Advisory Board:

No. 220

Akio Watanabe (Chair)
Masashi Nishihara
Yoshiji Nogami
Taizo Yakushiji

05 November 2015

Editorial Committee:
Taizo Yakushiji
Hisayoshi Ina
Tsutomu Kikuchi
Shujiro Urata andToshiro Iijima

THE CHY ISSUE BECOMES A GLOBAL
RISKToshiya Tsugami
・ The Chinese economy is unlikely to show robust

Editor & Online Publisher:
Yoshji Nogami
President, JIIA

recovery within the next five to ten years - this is a"new normal" that the rest of the world will need to facesquarely.
・ However, the fact that the Chinese economy faces
problems does not necessarily mean China will suffer
most; rather it is likely that neighboring Southeast andNortheast

Asian

countries

as

well

as

resource-producing countries will suffer more.
・ The Chinese Yuan (CHY) issue seems particularly
worrisome. The world will need to accept either
Renminbi devaluation or China's sell-off of its foreign
reserves followed by a potential USD interest rate rise,a choice that the world has not confronted before. Afterthe coming US interest rate rise and the Chinese
economic slowdown, this is the third greatest risk thatthe global economy faces today.
The views expressed in this piece are the author’s own and should
not be attributed to The Association of Japanese Institutes ofStrategic Studies.

AJISS-Commentary
The Association of Japanese Institutes of Strategic Studies

On top of the continuing economic slowdown, recent news of the stock
bubble collapse and the Chinese Yuan (CHY) devaluation has further
exacerbated disquiet about the Chinese economy.
China’s economic growth rate has perhaps already dipped below sevenper cent, but the Xi Jinping administration is unlikely to kick off a large-scaleeconomic stimulus because the administration is aware that the investment-led
economic growth model has already reached its limit. According to official
statistics, cumulative “fixed asset investments” from 2009 to 2014 – comprising
capital investment in the manufacturing sector, real estate investment andinfrastructure investment by governments – already exceed 200 trillion CHY(roughly 31 trillion USD).
Not all industrial sectors and regions are in bad shape; industries relating
to service, consumption and IT are still growing fast. If the administration can
properly encourage further growth in these sectors, then they will become thenew engines for future economic growth (but the opposite is also true). In any
case, however, such bright spots in the economy are not large enough to replace
the slowdown in investment.
The Chinese economy is unlikely to return to robust growth over the next
five to ten years. This is a “new normal” that the rest of the world needs to facesquarely. There are still voices abroad calling for a large stimulus package, but
the Xi administration will not accede to this request. Even if it were to do so, wewould need to anticipate a hard landing sooner or later.
The fact that the Chinese economy faces such problems does notnecessarily mean that China will suffer most. For better or worse, thegovernment’s power to influence the economy is much stronger in China than inother countries. Thus it is more likely that neighboring Southeast and Northeast
Asian countries as well as resource-producing countries will suffer more.
On 11th August, the People’s Bank of China (“PBoC”; China’s centralbank) announced that it had revamped the CHY exchange rate mechanism andguided the CHY-USD rate downward for three consecutive days. Most media
reports that this was an injection of cheap CHY meant to drive exports werewrong. Evidence shows that this was actually a response to the International

http://www.jiia.or.jp/en/commentary2

AJISS-Commentary
The Association of Japanese Institutes of Strategic Studies

Monetary Fund (IMF)’s suggestion that the CHY regime be reformed and thatCHY rates be allowed to move more freely. China did so in order to let the CHY
play a major international role.
Both the IMF and the PBoC overlooked one fact, however. While the CHY
has long been undervalued and is anticipated to rise in future, China’s recent
and significant monetary easing, the astronomical amount of ineffective
investments and soaring labor costs have considerably weakened the value ofthe CHY. As a result, both Chinese enterprises and individuals now anticipate
that the CHY will fall in future and prefer holding USD to CHY since last year.
The PBoC’s revamping was carried out under such circumstances andwas viewed as an injection of cheap CHY, which then prompted large-scale
speculative bets on CHY devaluation in the market. Last August and September,
China’s foreign currency reserves fell by 94 billion USD and 43 billion USD
respectively, presumably as a result of PBoC market intervention designed toprevent the CHY from falling.
Maintaining a relatively high exchange rate seems to be rather toughfor the current Chinese economy and, taking into account China’s contribution to
global economic growth, allowing the CHY to take a breather and devaluate by
ten to twenty per cent might even be beneficial for the entire global economy.
Once this happens, though, developing countries and emerging
economies might then be faced with devaluation dominoes, and some of themmight fall into a currency crisis. Instead, if we demand that China stabilize CHY
exchange rates, then it might need to sell off USD-denominated bonds, including
US treasury bills, in order to intervene in the currency market.
The US Federal Reserve Board (FRB) has acquired 3.5 trillion USD inbonds since the Lehman Shock and, over that same period, the PBoC has
picked up another 2 trillion USD in foreign denominated bonds for a total of 3.6
trillion USD, of which more than half is USD-denominated. If the PBoC sells
these bonds in haste, then it would risk triggering a bond price collapse, whichwould mean a sudden interest rate rise. In a sense, the PBoC has now become
a “shadow FRB” that can influence US interest rates. This is something that theworld has not confronted before. After the coming US interest rate rise and the

http://www.jiia.or.jp/en/commentary3

AJISS-Commentary
The Association of Japanese Institutes of Strategic Studies

Chinese economic slowdown, this CHY issue is the third greatest risk that theglobal economy faces today.

Toshiya Tsugami is the President of a Tsugami Workshop Ltd.,. After graduated from
Tokyo University in 1980, Tsugami served for the Ministry of Economy, Trade andIndustry (METI) and experienced China’s WTO entrance negotiation, Economic
Counselor of the Embassy in Beijing and Director for Northeast Asia of METI. Heis now working as an independent China business consultant and is also one of themost famous China Economy experts in Japan.

http://www.jiia.or.jp/en/commentary4