China’s economy faces headwinds, but don’t fear another 2015 crisis
- While sharp depreciation is unlikely, short-term pressures on the yuan will remain as China’s economy tries to rebound from the pandemic
- Market watchers should keep an eye on China’s central bank and see how it tries to maintain support while also supplying monetary stimulus
This time, it is clear China’s fiscal and external positions are different. The 2015 episode was triggered in part by the “taper tantrum” as US monetary policy tightened and China faced significant capital flight because of elevated foreign debt repayments denominated in US dollars. Today, there is less pressure on servicing foreign debt and relatively effective capital controls in place supporting a healthy capital account.
In addition, China’s current account surplus has grown larger as global demand for Chinese exports remains robust and domestic demand has weakened. Chinese commercial banks built up ample foreign asset positions during the currency appreciation cycle in 2020-21 that should act as a buffer.
This implies the chances of a conventional financial or currency crisis are lower than feared and could help explain the strength of the onshore yuan. The trade-weighted China Foreign Exchange Trade System index is still close to 101, compared to pre-2020 range of 92 to 96, mostly because of the recent strengthening of the US dollar. This could mean there is further room for the yuan to depreciate and gives the People’s Bank of China (PBOC) more space to manage monetary policy easing without setting off a chain reaction.
The lack of support could signal that policymakers are taking a more hands-off approach towards currency intervention or that the PBOC thinks the currency is still overvalued. A weaker yuan benefits Chinese exporters, though I don’t think policymakers will tolerate a disorderly fall in the currency that could threaten the stability of the financial system.
Regardless, the same macroeconomic factors that are punishing Chinese financial assets weigh heavily on the currency as well. To ward off growth headwinds and a depreciating yuan, supportive policy actions are key to watch out for going forward.
Meanwhile, we can imagine more countries taking a second look at their reliance on the US dollar as the default currency for foreign exchange reserves. The yuan would be a natural benefactor of this, and we should watch closely how the foreign exchange mix shifts in the coming years.
While sharp depreciation is unlikely, short-term pressures on the yuan will remain as the economy tries to rebound from pandemic uncertainties and aggressive tightening in the US. For the time being, the PBOC is unlikely to take a strong hand and hold the currency at a particular level. If volatility leads to too much capital outflow and depreciation pressures build, though, regulators are likely to defend the currency more robustly.
David Chao is Invesco’s global market strategist for Asia-Pacific