In recent weeks, the renminbi has depreciated significantly against the US dollar. Chi Lo, our senior market strategist in Hong Kong, explains what is happening and give his outlook for the Chinese currency.
The renminbi exchange rate against the dollar (CNY-USD), fell from 6.36 to 6.78 (a 6.6% drop) in just a couple of weeks between the end of April and early May (see Exhibit 1). What happened?
There are a number of reasons:
No. The PBoC has a stable exchange rate policy targeting primarily the CFETS index, using the RMB-USD cross-rate as a balancing factor, all else being equal. Under normal market conditions, when the CEFTS is rising, the PBoC will guide RMB-USD lower to offset some of the upward pressure on the CFETS basket, and vice-versa.
However, contrary to the market’s perception, China is not just targeting a stable RMB-USD cross-rate. It only prioritises stabilising RMB-USD when the market is volatile as the cross-rate is more visible to the public than the CFETS.
The sharp depreciation of other Asian currencies, especially the Japanese yen, against the strong US dollar has pushed up the CFETS sharply since late 2021 (see Exhibit 2). The Chinese authorities are uncomfortable with this. As the dollar has gone from strength to strength recently, the PBoC has tolerated more RMB-USD weakness to lessen the appreciation pressure on the CFETS; RMB-USD weakness is not a devaluation move.
The PBoC wants the renminbi to display two-way fluctuations around its ‘fixing’ as part of the bank’s foreign exchange reforms. It will intervene in the market to stamp out any one-way speculation.
Capital controls are the last resort. The other common tools include, but are not limited to:
It is likely to, as near-term depreciation pressure on the renminbi will probably remain strong, namely:
Given that the CFETS exchange rate has risen notably, and assuming other currencies in the basket do not move by much, the PBoC will likely allow the RMB-USD cross rate fall to 7 per USD in the near term to drive CFETS down towards 100 from the current 103-104 level.
Beyond the near term, however, fundamental support for the renminbi from China’s basic balance is still solid. The country’s current account balance is in surplus and China still benefits from net foreign direct investment (FDI) inflows.
Once market and investor sentiment on China improves, net portfolio inflows should return. Given the existing fundamental support, these factors should allow the renminbi to recover next year.
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