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Here’s How China ‘Encourages Capital Flight’ from the Country

November 22, 2016

General Scenes Of The PBOC And Economy In BeijingGeneral Scenes Of The PBOC And Economy In Beijing
A commuter walks past the People's Bank Of China (PBOC) headquarters in the financial district of Beijing, China, on Sept. 12, 2014. Brent Lewin/Bloomberg via Getty Images

The new way China fixes the yuan exchange rate “encourages” capital flight and has led to a gradual depreciation of the currency, a former member of the central bank’s Monetary Policy Committee said on Tuesday.

Yu Yongding wrote in the Shanghai Securities News that the new mechanism adopted by the People’s Bank of China to set the yuan’s midpoint rate did not allow for “true two-way volatility” in the exchange rate, and had hurt foreign exchange reserves as a result.

“Preventing the yuan from reaching market equilibrium is objectively a rejection of raising the cost of capital flight,” wrote Yu, a former adviser to the PBOC and one-time member of its monetary policy committee.

“It even encourages capital flight.”

Before the changes adopted in August, the PBOC set the daily fixing by asking currency market makers for price quotations. The new mechanism to fix the yuan midpoint is based on the closing price from a day earlier and by reference to a basket of currencies.

International Monetary Fund Deputy Managing Director David Lipton said at a forum in Beijing on Tuesday that over the past several years the PBOC decided to give more weight to the basket rather than think about yuan parity just with the dollar.

“The main point is that more and more the PBOC is allowing flexibility and market forces to be the determining factor and what we’re seeing is that the RMB tends to move more with the basket rather than any particular currency,” said Lipton.

The yuan, also known as the renminbi, has fallen 6.1% against the dollar so far this year, and hovered near an 8-1/2-year low on Tuesday. So far this month it has lost around 1.6% against the greenback.

Reuters reported last week that Chinese policymakers were prepared to slow the yuan’s decline because they feared rapid capital flight if the currency fell too quickly, and especially if it fell through the psychologically important 7-per-dollar level.

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A commentary on Tuesday in the official Economic Daily newspaper said that China must rely on structural reforms to reverse expectations for yuan depreciation.

The yuan was trading around 6.89 per dollar on Tuesday.

Yu, an academic at the Chinese Academy of Social Sciences state think tank, wrote on Tuesday that the independence of monetary policy had been affected by the new yuan fixing mechanism and it had worsened the market distortions caused by capital controls.

However, Yu also noted that Chinese economic fundamentals did not support a sharp depreciation in the yuan.

“We have capital controls as the last line of defense. It is not necessary for us to worry too much about the short-term and volatile depreciation in the yuan,” Yu said.