China's weekend reform of its currency regime nails shut the coffin on the last remains of doubt about whether the world's second biggest economy has successfully steered a course past a hard economic landing.
Investors were questioning whether the worst sequential slowdown in China's economy since the 2008-09 global financial crisis could enter a sixth quarter after data on Friday revealed the weakest three months of annual growth in three years and a run rate below the official 7.5 percent 2012 target.
Shifting the yuan trading rules is about the strongest signal Beijing could give that growth downside has diminished and potential pitfalls are manageable. Few reforms are as replete with risk as tinkering with the currency because faith in its soundness directly correlates to economic stability.
For everybody who thought China was heading for a hard landing, it's over. This move says they are comfortable with the direction the economy is moving in, Paul Markowski, president of New York-based MES Advisers and a long-time investment adviser to China's monetary authorities, told Reuters.
International investors are certainly in need of something to calm concerns about the health of the global economy after asset markets worldwide were rattled on Friday by a combination of below-par Chinese growth data and renewed fears of contagion risks in the debt-plagued euro zone.
Timing, politics and diplomacy are all in focus after Saturday's milestone step towards turning the yuan into a global currency that doubled the size of its trading band against the dollar to 1 percent.
But the economics of the move, predicted by a Reuters poll four weeks ago, are the most crucial for the 200 million or so jobs in China's vast factory sector that analysts estimate directly depend on foreign trade.
Reform says Beijing is comfortable with the yuan's value and that exporters have sufficient strength to cope with the government relaxing its grip. As the financial crisis deepened in 2008, China squeezed tightly on the yuan to shield the economy as international trade ground to a halt.
It implies confidence that rebounding March indicators in the first-quarter GDP data - such as a jump in steel production, vehicle output, machinery and cement production and a recovery in sales of household electronic appliances - suggest that the floor in economic activity has broad foundations.
So does a huge bounce in new bank lending in March - 25 percent ahead of economists' forecasts at 1.01 trillion yuan - that signals monetary easing since the autumn, creating an estimated 800 billion yuan of new credit, is being put to work.
Bear in mind that the last time growth was this low, in the second quarter of 2009, Beijing was busy rolling out 4 trillion yuan ($635 billion) of stimulus to support the ailing economy and encouraging local authorities to go on a borrowing binge.
The lessons from that episode though have been hard learned, requiring a two-year policy tightening campaign to fight the inflationary effects of the stimulus and creating a 10.7 trillion yuan legacy of local government debt to be cleaned up.
This time Beijing is taking a different route to stability.
This is all about creating macroeconomic flexibility in an economy that, by the end of the decade, is likely to be on a growth trajectory down towards 5 percent and where that flexibility is going to be needed even more, Markowski said.
UNSUSTAINABLE WITHOUT REFORM
Economists believe that a tightly-controlled export and investment-driven growth model that has delivered three decades of double digit expansion, lifted 600 million people out of poverty, and turned China into the world's single biggest source of economic growth and the Number 1 exporter, is unsustainable.
So too does the government, wary that a wealth gap is widening, asset bubbles are inflating and foreign demand for goods from China's vast factory sector is becoming less reliable, fuelling economic risks that undermine the social stability on which the Communist Party claims the right to rule.
The International Monetary Fund hailed Saturday's move as underlining China's commitment to rebalance the economy towards domestic consumption and giving market forces more freedom.
Premier Wen Jiabao last month staked his political legacy on the need for structural reforms to rebalance China's economy, while Li Keqiang, widely expected to succeed Wen early next year, told a forum last month that reforms cannot be delayed.
Beijing is actively pursuing a slower growth strategy to deliver them, with an official target at an eight-year low to create room for structural policy shifts, particularly on prices it sets, without sparking a surge in inflation.
Economic stability is the most crucial part of the plan.
The move may partially help clear away the doubt on whether China could manage to steer a soft landing and make global investors more clear about China's reform roadmap, said Dong Xian'an, chief economist at Peking First Advisory in Beijing.
The fundamentals of China's economy have shifted, particularly with respect to its huge accumulation of foreign capital over the last decade that has given it the world's largest store of foreign reserves, worth $3.3 trillion.
China's current account surplus dropped from about 10 percent of GDP in 2007 to 2.7 percent in 2011 and is likely to remain subdued while its two biggest trading partners - the European Union and the United States - struggle respectively with recession risks and anaemic growth.
A surplus between 2.5 and 4 percent of GDP is, according to a model backed by the influential Peterson Institute for International Economics, an indication that a currency has reached its fair, or equilibrium, value. China's top officials have used that term a lot recently.
That only serves to reinforce the view that Beijing is satisfied it has the policies in place to ensure that even if annual growth in 2012 does end up being its slowest in a decade, it sets the scene for better quality growth in the decade ahead.
And it implies confidence that the incremental introduction of more currency flexibility will not knock economic activity off track near term as the risk of a hard landing has gone.
As long as the current modest easing is carried out - with the budget deficit increasing by almost 1 percent of GDP and new bank lending reaching at least 8 trillion - we think growth will rebound in Q2 sequentially and average 8.5 percent for 2012 as a whole, analysts at UBS said in a note to clients.
(Reporting by Nick Edwards; Editing by Emily Kaiser)