The Treasury Department late Tuesday used its latest semiannual report on currency regimes to press China to resume appreciation of the renminbi and to let the world know its intentions about currency management.
The report also warned that Europe risks “outright deflation,” and said that Germany has increased domestic demand only rarely throughout the last decade, progress that is inadequate toward a fundamental rebalancing of internal and external demand.
It said Japan’s resurgence has not seen much of the progress necessary on the “third arrow” of Abenomics, the structural reforms that can more permanently capture the economic gains made so far after a decade and a half of stagnation, the report noted.
South Korea was chided for resorting to presumed FX market intervention and told it must restrict such drastic moves only to rectify disorderly markets, not just to make won-denominated exports more attractive.
Treasury refrained as expected from formally designating any country as a manipulator of its currency for an advantage in trade, although it acknowledged outsized trade and current account surpluses in Asia and Europe that can accumulate because of currency undervaluation.
Treasury said that considering all of last year, China did allow its currency to appreciate 2.9% against the dollar and more than twice that much against a basket of currencies that included the yen and emerging market currencies – but only to see the progress reversed with a depreciation so far this year of 2.7% so far this year.
In recent comments, Treasury Secretary Jack Lew has to some extent given China limited benefit of the doubt, acknowledging authorities needed to send a signal to speculators that the renminbi can go down as well as up so to disrupt the so-called carry trade.
The FX report noted the “highly profitable” positive carry available to offshore investors in China currency through the non-deliverable forward market. However the report blamed the development “partly” on the relative inflexibility of Chinese currency policy.
“The introduction of RMB volatility in February 2014 has led to an unwinding of carry trade positions in the short-term,” the report said. “The RMB’s attractiveness as a carry trade currency has been partly a function of the PBOC’s unwillingness to allow the exchange rate to adjust to appreciation pressures stemming from China’s large current account surplus and foreign direct investment inflows.”
In the longer term, the U.S. has expressed its hope that RMB appreciation will resume and Lew has expressed frustration with the opaque nature of China’s intentions, with no recent explicit signal as to when that appreciation will get back underway, if at all.
Even last year’s appreciation of the RMB on a trade-weighted basis was insufficient, the Treasury report said, being neither “as fast nor as much as is needed.” The report did note that the modest appreciation that did occur was “in contrast to the large depreciations of the yen and many emerging market currencies” that tended to amplify the RMB appreciation.
Having expressed these sentiments in other fora, voiced by the Treasury secretary, the department’s repetition of concerns in the FX report, using relatively mild language, may add little if anything to their impact.
In similarly mild fashion, the report did not heighten the emphasis used last year to urge “surplus” nations in Europe, of which Germany is the most prominent, to increase demand to combat the “significant macroeconomic and financial headwinds.”
The report said that “with inflation in the euro area dropping to new record lows in recent months and the risk of further financial volatility in emerging markets having an adverse impact on global demand, Europe faces the risks of a prolonged period of substantially blow-target inflation or outright deflation.”
“In Germany, domestic demand has grown faster than GDP only three times in the past 10 years,” the report noted. “Stronger domestic demand growth in all surplus European economies is needed to help facilitate a durable rebalancing of imbalances in the euro area.”
Far from fueling demand, the report said, Germany let its import purchases decline 1.0% last year.
Europe needs to allow more flexibility in hitting fiscal targets, attenuating austerity in the pursuit of growth which itself will, the report said, “support reduction of heavy debt burdens.”
Japan’s domestic demand has increased, the report noted, contributing 3 percentage points to growth over the four quarters of last year that was accompanied by a slight decline in the country’s reliance on exports.
To sustain domestic demand growth Japan needs to keep increasing business and residential investment, household consumption and wage increases above the inflation rate, the report said. Monetary policy alone “cannot offset excessive fiscal consolidation nor can it substitute for structural reforms needed to raise trend growth and domestic demand.”
South Korea appeared to intervene on both sides of the market” for currencies last year “but on net they have intervened more aggressively to resist won appreciation,” the report said.
But exchange rate appreciation should be “an important tool” in rebalancing Korea’s economy away from export dependence and noted there is an “ambitious” reform program underway to expand the services sector.
“Unfortunately, Korea does not publicly report foreign exchange market intervention,” the report said. “The Korean authorities should limit foreign exchange intervention to the exceptional circumstances of disorderly market conditions, increase transparency of foreign exchange intervention, approve the timely publication of the IMF’s recent article Iv surveillance report and ensure that macroprudential measures clearly focus on reducing financial sector risks,” the report said.
Instead, the report implied South Korea is focusing excessively on the short-term problem of upward pressure on the exchange rate rather than longer term rebalancing. The reference to the nonpublication of the IMF’s annual review of the South Korean economy, completed three months ago, appeared to be a reproach for not following the advice contained in the previous IMF review, that there was “no need for further reserve accumulation.”
The report observed that large current account surpluses in China and Germany highlight “the need for concerted progress on global rebalancing, including boosting domestic demand.”