Fitch does not expect large trade-weighted depreciation of Chinese yuan

The People’s Republic of China was facing the classic policy dilemma of all countries who simultaneously attempted to try to freely use exchange rates and interest rates while allowing free capital flows, Fitch Ratings said.

It is not possible.

Hence, while officials in Beijing had lowered interest rates to prop up economic growth, that had led to a narrowing in the interest rate gap versus the US – where rates were headed in the opposite direction.

Yields on two-year Chinese government debt had retreated from 340 basis points in July-August 2014 to only 150 basis points in December 2015.

During that same time frame capital outflows had likely increased past the $1trn mark.

“China still operated capital controls, but the scale of flows suggested that these have become porous,” Fitch said.

Nonetheless, the ratings agency did not expect the economy to experience a so-called ‘hard-landing’ as domestic consumption was expected to continue holding up, despite the gyrations in the stockmarket.

Likewise, Fitch did not think Beijing would turn to a large trade-weighted yuan depreciation to solve its problems.

“This would risk creating additional uncertainty and further undermining policy credibility. It would also work against the broader priority of rebalancing the economy by strengthening the position of exporting corporates,” the agency said.

Fitch forecast the rate of growth in China’s gross domestic product would slow from 6.8% in 2015 to 6.3% in 2016.