No Need for China to Overly Worry about the Fed Rate Increase

The Federal Reserve raised the interest rate by a quarter of a percent last Thursday, worrying some people that the RMB* and China’s macro-economy would be impacted. However, China is well prepared in this area and is resilient toward risks in the financial market.

The rate increase is not sudden; it was well anticipated by the market. While waiting for the Fed to raise the interest rate, China already made necessary adjustments. For example, China has pushed some short-term foreign investments out of the Chinese market by repeatedly lowering the interest rate this year, as well as readjusting its exchange rate policy to keep the RMB-to-dollar exchange rate at a reasonable and appropriate level.

As to whether the RMB will continue to depreciate after the Fed rate increase, it needs to be examined along with other currencies. In fact, based on the RMB exchange rate used by the China Foreign Exchange Trading System, which is calculated from trading, the RMB’s effective rate is increasing overall this year. Even if we only paid attention to the devaluation of the RMB in relation to the dollar, this may not be a bad thing for China, as Chinese exports will now benefit. Will the devaluation of the RMB lead to more capital outflow and trigger volatility in the Chinese capital market? The answer is also no. China still owns the world’s top foreign currency reserve, has medium-level to high-level economic growth and healthy financial status, all of which ensure that the Chinese government has plenty of room in its policies to respond to extreme conditions.

Some people worry that the Fed rate increase will lead to a global downturn in liquidity, and liquidity issues in China. Two weeks before the Fed rate increase, the European Central Bank increased its quantitative easing, deciding to lower its deposit interest rate by 10 basis points to -0.3 percent. The Bank of Japan also decided in November to maintain its original quantitative easing policy. The policy decisions by the European and Japanese central banks and the American currency policy support further liquidity in the global financial market, partially counteracting the effects of the Fed rate increase. More importantly, China owns the issuing scale for the world’s largest monetary base, it can lower the deposit reserve rate or the interest rate to increase liquidity, and it can prevent any issues due to a lack of global liquidity.

Worries over the Fed rate increase affecting the RMB’s entry into the world market also lack support. In the past few years, the regionalization and internationalization of the RMB has continued, and the RMB joining the SDR** was a clear sign of progress. This is an inevitable result of the development of the Chinese economy and trade, and not directly related to the Fed’s currency policy. Interestingly enough, if the Fed rate increase really led to the devaluation of the RMB, this could actually lead to the internationalization of the RMB, as this would indicate the Chinese government is controlling the RMB exchange rate less and the rate is more determined by the market.

Ultimately, we need to judge how the Fed’s currency policy changes affect China as part of the new global financial framework. As the Chinese economy rises, China needs to be more leisurely toward anticipated currency policy changes from the Fed. The strong growth of China’s financial strength means not only our ability to counteract volatility in the global capital or currency market, but also an ability to make our policy shape other countries’ currency and financial policies. When the Fed increases its interest rate, we should pay more attention to the changes in Chinese currency policies and other macroeconomic policies, and potential changes to international finance and the world economy.

The author is Associate Director of the American Studies Center at Fudan University.

*Editor’s note: RMB is the abbreviation for the Chinese currency renminbi.

**Editor’s note: SDR stands for Special Drawing Right, which is an international reserve asset created by the International Monetary Fund in 1969 to supplement its member countries’ official reserves.