1. early 1990s
As a planned economy, China conducted government-led projects to boost economic growth with a huge devaluation of RMB. As a result, inflationary pressure had increased and people were suffered especially because of lack of investment vehicles protecting inflation such as stock or bond market. Despite the pain, Chinese government shouldn't stop this business, because if they paused economic plans, people would be suffered more with the mega unemployment. So, government started to consider economic reforms.
2. mid 1990s
China decided to adopt Exports-led Economic Model and thus economic growth started to be boosted by exports sector with relatively weak real effective exchange rate as China pegged RMB to USD. In fact, pegging local currency to dollar was the main mandate for Asian countries which adopted exports-led economic model, succeeded in Japan earlier, including from Korea, Taiwan, Hong Kong to Malaysia. As you know, they experienced financial crisis in late 1990s, but China was somewhat free from the crisis. It was because China was controlled economy, especially in capital accounts, so their external debt was much smaller than other Asian countries.
3. late 1990s
PBOC purchased FX to hold exchange rate for pegging and it could led the inflation to decline rapidly. But, the world was somewhat upset because they couldn't get dollar absorbed in China again. There was a criticism that China broke a WTO policy. On the other hand, many corporations in developed countries, such as U.S, Europe and Japan, seemed not reluctant weak RMB because they were transferring their factories into China as pursue competitiveness of lower cost. Those two factors offset.
4. early 2000s
Chinese FX reserves increased more rapidly in early 2000s. They bought US treasury bonds massively and Fennie and Fraddie bonds to use dollars. It was one of a reason for so-called Greenspan's conundrum, long-end bond rate did not rise despite hiking Fed funds rate. Moreover, it would be another rationale for housing bubble in U.S, because their buying bonds issued by mortgage firms lowered their capital costs.
5. mid 2000s
In this period, Chinese government decided to conduct structural rebalancing to increase domestic consumption. For this, they started to appreciate RMB, albeit there were many criticism that RMB would be much stronger. Anyway, as a consequence, as you know, the super cycle in commodities started under massive consumption by China. Meanwhile, China established C.I.C, a sovereign wealth fund, for appropriate investments of FX reserves and allowed individuals to invest on equity markets in Hong Kong and U.S.
6. in 2008
Global financial crisis was. China recognized they should reform the economy like other countries following commodities drop and economic recession. They set RMB market to diversify three things, on-shore CNY, off-shore CNH, and off-shore and USD-settled NDF of CNY. However, they couldn't give up their mandate to pursue both of exports-led economy and rebalancing to boost internal consumption. So, they decided to increase expenditures from government and corporations to boost economy, and it meant increased debts.
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| Source : IMF |
7. by 2013
Continuing double economic mandate in China pointed the possible and moderate appreciation of CNY further for market participants. And so, Chinese industrial firms started to pursue higher yield from leverage positions borrowed in USD, and this money moved into shadow banking. On a early stage, they used commodities in their hand as a collateral. But, after commodities price dropped, they used gold and invoices of exports as a collateral as a popular theme. In fact, short term foreign debt increased rapidly since 2009.
8. in 2014
Chinese government had to warn this leverage positions. They started to recognize current environment as different from mid 1990s when they could avoid from financial crisis. So, they depreciated CNY rapidly and unexpectedly. Surprised leverage positions started to run out from on-shore market. There have been massive capital outflows since 2014 as flee from both of domestic deleveraging and investment capitals form overseas since then. In this circumstance, under the burden of debts for Chinese companies, capital outflows threatened banking system. So, China had to start to cut both of RRR and base rate in late 2004.
9. in 2015-ing
Chinese government seems afraid of possible more speedy capital outflow in line with deleveraging of domestic companies ahead of monetary tightening from U.S Fed which could lead stronger USD than now. So, China must need to include CNY into SDR in IMF to boost external demands of RMB for weakening shock from capital outflows, while they intend additional deleveraging modestly. So, they decided to devalue CNY, right after the warning sign from IMF, and before U.S Fed starts to hike the policy rate. It's maybe not for spurring exports sector.
10. Conclusion
Chinese government seemed to follow a planned step for restructuring economic model to open capital markets to maintain the status for global manufacturing and economic rebalancing to boost domestic consumption. On this side, current woes about devaluation of CNY are likely over stated and it will be positive rationales for Chinese economy in longer-run.
However, in short-term, we should concern how much possible capital outflows remain and the shock is. These are very difficult to estimate for now. Moreover, many suspect the ability to handle this in Chinese government. To confirm this, we have to wait further, and risky assets could face a headwind continuously, in short run, at least.
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