Official says China won't take part in currency wars

China won't engage in any "currency wars" by depreciating the value of the yuanthrough monetary easing policies to shore up the economy, as some major economieshave done, said a former deputy central bank governor on Tuesday.

"The yuan will continue to fluctuate in both directions as the central bank strengthensmarket-oriented reforms," said Wu Xiaoling, who is still closely connected to thePeople's Bank of China and is now the vice-chairman of the National People'sCongress Financial and Economic Affairs Committee.

The easing policies conducted by some major economies, such as Japan, are similar to"quenching thirst with poison", she said at a press conference.

"Printing more money and devaluating the currency could be useful to promoteeconomic growth over a certain period. But if a country doesn't have a sound economicstructure or strong growth momentum, it would be poisonous to depend on a loosermonetary stance," Wu said.

Her remarks come after a report in Japan's leading economic daily Nikkei said that theBank of Japan's recently appointed leaders might launch fresh easing measures beforetheir first policy meeting next month.

The yen was under pressure in Asia on Tuesday as the US dollar strengthened, with96.7 Japanese yen against the greenback, the highest level since August 2009.

The yen has depreciated about 20 percent since the new Japanese government tookoffice at the end of last year. In January, the BOJ announced plans to undertake"unlimited" easing policies to fight against the country's lingering deflation.

"Instead of intervening in the currency market to contain appreciation and stimulateexports, China needs to create a fair and competitive financial environment fordomestic companies, and continue to promote the reform of the international monetarysystem," Wu said.

She said the yuan's exchange rate is already very close to its equilibrium level as thedifference between the onshore rate and its non-deliverable forwards on the offshoremarket is narrowing.

PBOC's deputy governor Yi Gang last week urged major economies to avoid thecompetitive devaluation of their currencies and said that G20 countries should complywith the group's joint statement and reach a consensus.

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Why China fears currency wars

China was never likely to receive much sympathy by complaining about other countries engaging in so-called currency wars.

If there is a modern mercantilist blueprint Beijing surely wrote it — its longstanding dollar peg saw it rack up decades of double-digit export growth and the world’s largest pile of foreign reserves.

And on cue, February’s expectations-beating 22% surge in exports suggests China’s exporters are still winning any trade skirmish.

On the surface, this makes repeated saber-rattling comments about currency wars by Chinese officials appear unnecessary, if not somewhat odd.

On Friday, Commerce Minister Chen Deming was the latest to raise concerns about competitive currency depreciation and the effects of excessive money-printing by central banks.

The head of China’s sovereign-wealth fund was less diplomatic, reportedly warning Japan against “treating their neighbors as your garbage bin and starting a currency war.”

There were some clues, however, as to what lies behind this escalation in rhetoric in economic reports out this weekend.

While China’s exports impressed, its economy is showing some disturbing trends: cooling industrial output, weakening retail-sales growth and a spike in inflation. Read: China inflation climbs; other indicators soften

Specifically, February’s consumer price index hit a 10-month high inflation rate of 3.2%, beating expectations, while industrial output in January and February expanded just 9.9% from a year earlier, below expectations. Retail sales growth, meanwhile, fell to 12.3% year-on-year in the January-February period, down from 15.2% in December.

One familiar area where activity is picking-up is in property and infrastructure. Investment in fixed assets accelerated to 21.2%, with real-estate investment growing at an even faster 22.8%.

The property market is showing renewed signs of overheating. Sales have been soaring, rising 77.6% from last year’s levels in value terms over the first two months of 2013.

The snapshot suggests China’s recent economic recovery is far from assured. The massive lending figures seen at the beginning of the year appear to be generating more inflation than growth. To concerns about property bubbles, some might add looming stagflation.

Clearly the last thing China needs just now is a surge in hot-money flows through quantitative easing (QE).

We are familiar with Chinese officials in the past protesting QE by U.S. Federal Reserve Chairman Ben Bernanke. With a large part of China’s $3 trillion foreign reserves held in U.S. dollars, Beijing has a keen interest in any greenback debasement.

There was at least a silver lining, however — as the U.S. dollar slid, so too did the yuan, which tended to give an extra boost to China’s exports.

This time, however, it is Japan in the firing line, following its recent adoption of ultra-loose monetary policy. It is also harder to see China’s silver lining.

Losing export competiveness against the yen is unlikely to be a big concern for China as the countries are rarely direct competitors. But Japan’s quest to raise inflation will worry Beijing if it also succeeds in chasing up prices in China.

Since the middle of last November, the yen has fallen close to 18% against the dollar. This is likely to prompt capital flows into a hard currency, and here the yuan stands out in Asia as attractive, with its managed float against the relatively robust-looking greenback.

While China officially operates a closed capital account, it is also the world’s largest trading nation, so keeping its borders sealed to money flows will inevitably be a challenge.

The latest figures showed a surge of money heading into China. Last week, China’s central bank reported that companies and individuals changed 684 billion yuan ($109 billion) worth of foreign currency in January. This was a record for a single month, and the data point is often used as a proxy for hot money flows.

For China, currency wars appears less about export competitiveness and more about fears of further fanning domestic inflation and property bubbles. With a fixed exchange rate and porous capital controls, China risks losing control of its own monetary policy.

This also presents a policy dilemma.

If China were to hike interest rates to curb inflation, the risk is this will only attract more capital as the interest differential with the yen or dollar widens.

But if Japan and other countries continue with QE, China may find it harder to keep speculative capital out.

One option would be for China to try to seal its capital account, yet that goes against its reform agenda to internationalize the yuan.

Perhaps the real reason behind the amplified currency war rhetoric is that China has been pushed into a tight spot. The end game could be floating its currency much sooner than it would have wanted.

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