U.S. Federal Reserve Increase Borrowing Rate for China to Balance Currency Stability
The Federal Reserve of the United States have increased its key borrowing rate that has been kept zero for seven years is now narrowing the scope for China to balance the currency stability with economic growth and is likely to push out more capital outflows from China and the depreciating yuan. The Federal Reserve raised the range if the benchmark interest rate by a quarter of a percentage point between 0.25 percent and 0,50 percent the first increase since 2006 that signals the end of monetary easing era.
The question now is for China in 2016 whether the country can reconcile their potential conflicting imperatives on the domestic and external financial stability. Rising corporate debts and the softening of the domestic demand in China justifies the lower interest rates, but as the U.S. rates rises, rate cuts in China will precipitate a flight of capital that searching for better returns. The rate hike was anticipated and most of its effect is already factored into China’s foreign exchange reserves and the yuan rate. The reserves fell by US$ 87.2 billion last November the second largest monthly drop since 2011. The yuan central parity rate against the US dollar has weakened for nine straight days, down to 6.4757 the lowest in the past four years.
These actions is placing pressure on the yuan and squeezes China’s room for reducing interest rates, and worse capital outflows might hit a property market that is already down with knock on effects in shadow banking and local government balance sheets. Although its not immune o the effects of the rate hike, China naturally consume foreign exchange reserves and sees currency fluctuations. The government is all ready and is willing to intervene when necessary, and with higher U.S. rates China is pressured to make its economy more competitive and appeals to foreign investors and to offset outflow risks, China increases returns on domestic assets as they stabilize growth and accelerate structural reforms.
Recently China altered now they measure the value of the yuan by moving from and exchange rate that relies on the U.S. dollar to the currencies of their trading partners. The new trade weighted yuan exchange rate index that measures the yuan strength relative to the basket of 13 foreign currencies, which includes the dollar, Japanese Yen and Euro. By allowing the yuan to fluctuate against the basket of currencies instead of the U.S. dollar the Chinese central bank has greater flexibility in dealing in the after math of a hike in the federal funds trate.