Fresh Supply

By Li Jia

With Microscene’s new tech service, when planning a family holiday, travellers can choose hotels, contact tourist attractions and even order umbrella-garnished drinks delivered to their exact location on the beach by zooming around panoramic shots of the area on their mobile phones and simply touching a spot on the screen. At the same time, data about their preferences are collected and analysed to help provide better services and develop more business potential for local hotels, tourist sites and government tourism agencies. Tiago Tan co-founded Microscene in Beijing three months ago. He told ChinaReport that his company is the first in China to integrate all these services and resources, and he plans to double its staff to about 60 people in early 2016 to deal with its fast-growing business.

While Tan expands his startup in the new year to bring in more yuan, China’s currency itself will be undergoing something new. On November 30, 2015, the International Monetary Fund (IMF) announced the decision to include the yuan in the Special Drawing Rights (SDR) basket of reserve currencies, a supplement to the official foreign exchange reserves held by IMF members. This means that the IMF has endorsed the yuan’s position as a new option for official foreign exchange reserves for its 188 member economies. The 10.92 percent share of the yuan, effective October 1, 2016, will be the thirdlargest in the basket, above the Japanese yen and pound sterling and below the US dollar and euro. The addition of the yuan will be the first change to basket currencies since the euro replaced the German mark and French franc in 1999.

The yuan’s inclusion is widely viewed as an important symbolic gesture. Both the IMF and the People’s Bank of China (PBOC), China’s central bank, highlighted in their statements and press conferences that the inclusion of the yuan in the basket is a “recognition” of China’s economic growth and past reform, and that their expectations for the internationalisation of China’s currency and the country’s stronger role in global financial governance will continue to depend on China’s growth and reform in the future. Chinese analysts hope that the yuan’s inclusion in the SDR basket will prop up not only international confidence in China’s economy and currency, but also the momentum of reform, similar to the effects China’s WTO accession had in 2001.

In the meantime, concerns over China’s growth prospects, the substantial foundation of its currency, compounded with the imminent US interest rate hike, appear to have led to the yuan’s constant devaluation in recent months. While trying to convince the market of the soundness of the country’s economic foundation, the Chinese leadership has recently come up with the idea of “supply-side reform” to sustain and improve China’s growth, providing better, more efficient goods and services, like those provided by Tan’s business, to expand and improve consumer demand. So while the new ventures of Microscene and the yuan may seem unrelated, they are closely linked beneath the surface. Chinese Premier Li Keqiang said on December 7 that supply side reform is all about empowering the market and encouraging entrepreneurship and innovation, particularly those endeavours based on the Internet.

Road to the SDR

The SDR was created in 1969 as a supranational currency to add to the inadequate supply of official foreign exchange reserves held in the form of gold and thfresh supply1e US dollar. IMF head Christine Lagarde coined it “the currency of currencies” in her November 30 statement about the yuan’s inclusion. After the US declared it would stop converting other countries’ official gold reserves into US dollars in 1971, countries turned to the international financial market, not the SDR, to finance their international payment deficit. The widely accepted estimation is that currently only 3 to 5 percent of official foreign exchange reserves involve SDRs.

This is why Chinese and IMF officials and analysts have stressed the symbolic, long-term significance of the yuan’s SDR inclusion in regards to the Chinese currency’s internationalisation and the global financial order. Few think of its immediate, substantial impact on the flow of capital or the valuation of the yuan. The two standards required of SDR currencies also reflect this point: the economy holding the currency has to be a major world exporter, and the currency must be widely used in international payments and traded on global forex markets. When the IMF reviewed the SDR basket in 2010, China met the first criterion but not the second, according to the IMF’s December 1 press release, which stated the yuan at the time was not “freely usable.”

China’s desire to join the SDR has been clear through the leadership’s and the PBOC’s actions. Most recently, diplomatic efforts resulted in the issuers of the existing four reserve currencies – the US, the UK, France, Germany and Japan – all giving their nods of approval toward the inclusion of the yuan right before the IMF made its decision. China has also made a series of changes in order to meet the IMF’s second criterion. In July, China’s interbank bond market opened up to foreign central banks and similar institutions. In September, the PBOC began to release more details about China’s official foreign exchange reserves in order to adopt IMF standards of transparency. In October, China’s interest rate system was essentially liberalised. Although these reforms would eventually have taken place anyway, SDR aspirations likely sped them up. It was widely speculated that the PBOC stepped in with official foreign exchange reserves to prevent the yuan from depreciating too much in August, out of concern that a rapidly weakened currency would not look attractive enough to warrant becoming a part of the SDR basket.fresh supply3


Faith in China’s economy and currency seems to be one of the main dividends that the SDR inclusion is expected to deliver. Yi Gang, deputy governor of the PBOC, said at a December 1 press conference that the market would become “more confident in holding yuan-denominated assets.” After China’s stock market chaos in June and July, some international fund managers decided to reduce their holdings of yuan-denominated assets, as they had doubts over China’s economic prospects and future reform, said Ba Shusong, chief economist of the China Banking Association and chief China economist at HKEx, at a December 1 forum sponsored by Sina Corp. He noted that the IMF’s decision and the changes made before the SDR inclusion would help recover and spur the confidence in and demand for yuan-denominated assets among international investors, both central banks and private holders.

There are already signs that interest in yuan-denominated assets has grown since the SDR announcement, despite the currency’s constant depreciation against the US dollar before and after the inclusion. On November 30, the day of the IMF’s announcement, the Working Group on US RMB (yuan) Trading and Clearing was established, led by US financial and industrial heavyweights like Michael Bloomberg and Timothy Geithner, with nearly all top US and Chinese banks included as initial members. At the end of November, monetary authorities and sovereign wealth funds from Australia, Hungary and Hong Kong, as well as World Bank Group agencies, became the first of their kind to enter China’s interbank foreign exchange market. The following month, South Korea defresh supply4clared its plan to issue yuan-denominated sovereign bonds in China’s interbank market, marking the first time a foreign jurisdiction had done so.

There is something larger on the wish list. Both the IMF and the PBOC have expressed the hope that the yuan’s inclusion would strengthen the SDR itself and bolster China’s role in the international financial system. Ding Yifan, a researcher with the National Strategy Institute, Tsinghua University, said at the December 1 forum that the financial world was facing significant uncertainties due to conflicting interests; mainly the US’s tightening of monetary policy, Europe’s policy easing and Wall Street’s call for more quantitative easing. He believes that European economies expect the yuan’s inclusion in the SDR to lead to a more diversified international financial system to hedge against these unknowns.

Ba Shusong has envisaged the possibility of a realignment of international currencies. When the yuan officially enters the SDR basket in October 2016, the combined total of the euro and the yuan will account for a larger share in the basket than the US dollar’s, though it will still be slightly less than the US dollar combined with the Japanese yen. He thinks this deviation from the existing structure dominated by US and European currencies could pave the way for a new lineup of players within the game of international financial governance.


Supply-Side Substance

Analysts have repeatedly pointed out the fact that the SDR inclusion would not automatically put yuan assets in other countries’ official foreign exchange reserves or on the to-invest lists of international financial traders. The future of the yuan on the market, like fresh supply2any other currency, lies in the economic power it represents. The inclusion of the SDR has not dissipated controversy in China over the timing of the further opening of China’s financial system, either. Past experiences of emerging and developing markets have shown how dangerous opening-up can be if an economy is not ready.

After the devaluation of the yuan in the past few months, top Chinese leaders and central bank officials have been attempting to reassure the market that China’s growth prospects remain robust enough to defend the yuan from long-term depreciation. On December 11, the yuan’s value versus the US dollar reached a four-year low in both onshore and offshore markets. On the same day, the PBOC’s China Foreign Exchange Trade System (CFETS) began to issue a new index that measures the yuan against a trade-weighted basket of 13 foreign currencies. The yuan’s value versus the basket is higher than its value versus the US dollar. Many interpreted the index’s launch as China’s way of readying the market for the further devaluation of its currency. On December 14, the PBOC published an editorial on its website stressing that China’s growth speed and productivity, as well as the yuan’s SDR inclusion and foreign exchange reserves, would underlie “basic stability of the yuan’s foreign exchange rate at a rational equilibrium level in the medium and long term.”

The market needs more than words to address the prevalent anxiety about the current growth slowdown and disenchantment with the progress of reform. Chinese President Xi Jinping pledged at a November 10 meeting to “endeavour to improve the quality and efficiency of the supply system to strengthen the dynamics of sustainable economic growth.” Ever since, “supply-side reform” has been in the headlines.

Supply-side economics, better known to some as Reaganomics, prioritises reducing producers’ costs and barriers through tax cuts and deregulation. It has ascended from what US President George H. W. Bush once coined “voodoo economics” to a new orthodoxy in the US and the UK during the Reagan and Thatcher administrations, utilised to deal with the stagnation of economic growth and the jump in inflation that the demand-oriented Keynesian school of economics had failed to address.

Oft-cited illustrative examples used by Chinese analysts and media are how Apple’s iPad created the demand for tablets and how Chinese tourists’ shopping frenzies in Europe and Japan have proven the existence of the gap between insufficient supply and enhanced demand. This phenomenon not only takes business away from the Chinese mainland, but can be risky as well. Chinese clients even rush to buy insurance in Hong Kong because they can find similar terms for a less expensive price, Ernst & Young’s Rick Huang told ChinaReport, warning that Chinese policy holders could face problems if they end up needing to make a claim from insurance firms who are located far away.

In China, steps to liquidate inefficient supply and to increase the efficient, longterm supply of market resources, capital, labour and energy have been pushed for at least a decade, but were finally taken only recently under the “supply-side reform” banner. On December 9, the State Council specified for the first time a timeline to eliminate “zombie enterprises,” mainly badly performing State-owned companies, and allow companies to float on the stock market without regulatory approval. A few days before that, rules were released on building a more competitive power market. The National Reform and Development Commission declared at a press conference on December 11 that reform plans for the oil, gas and salt industries had already been submitted to the State Council. Amendments to the national household registration system that come into effect on January 1, 2016, will give people more freedom to move around the country without worrying as much about governmentprovided benefits tied to their place of birth. Even Beijing, the most difficult place for internal migrants to relocate to in China, has recently clarified its terms of settlement. On December 9, the central government made it clear that parents will no longer have to pay a fine to register children who were born illegally under the old One Child Policy.

Such fines should be annulled to encourage the supply of human capital, said Zhou Tianyong, lecturer at the Party School of the Central Committee of the CPC, in an exclusive interview with the Chinese edition of ChinaReport. He added that businesses’ social security contributions should be reduced from around 45 percent of the wage to about 30 percent. He regarded these measures as equivalent to tax cuts. Tiago Tan, the Microscene co-founder, agreed, saying that “Internet Plus” industries that provide high salaries could benefit in particular from lower social security fees and individual income taxes. The World Bank’s Philip O’Keefe told ChinaReport that more childcare services should be provided and more effective communication with the public about retirement age should be made to increase China’s labour supply in the face of a rapidly ageing society.

Proposing change is one thing, implementing it is another. Liu Shangxi, director of the Research Institute for Fiscal Science under the Ministry of Finance, said at the 13th China Reform Forum on December 13 that government agencies have been busy making plans and reports on reforms, with little time and consideration spent on their efficient implementation. It is like “a car that is stuck on the ice, even though its wheels are spinning,” he said, expressing his concern that the public’s enthusiasm for reform has already dampened as a result.

It is widely recognised that China’s progress towards reform over the past two years has been greater than in the previous decade. However, the market is never patient. Policymakers must always take this into account in the reform process.

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