South China Morning Post
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The People’s Bank of China has responded to the latest renminbi depreciation pressure with a laudable policy of “benign neglect”. Photo: Reuters
Opinion
Yu Yongding
Yu Yongding

China should keep focusing on growth and not worry about a weak yuan

  • The yuan has weakened significantly against the dollar multiple times since 2015, with the People’s Bank of China fighting to defend its value for fear of a collapse
  • But despite a sharp depreciation again this year, policymakers have held back, suggesting a stronger confidence in the Chinese economy
Yu Yongding
Yu Yongding
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The renminbi’s value used to feature heavily in debates about global imbalances. While outsiders considered it to be undervalued and urged appreciation, the People’s Bank of China (PBOC) insisted on maintaining the currency’s de facto peg to the US dollar. In recent years, however, China’s concerns that its currency would grow too strong have been replaced by fears of a sharp depreciation.
Though China has sustained its current-account surplus, capital outflows have been putting the exchange rate under frequent downward pressure since 2015. The sources of the pressure can be divided into three broad categories: deteriorating domestic economic conditions, non-economic factors and arbitrage.
In 2015, while equity prices crashed and led to months of market turbulence, and GDP growth was losing momentum, the PBOC introduced a new rule for setting the renminbi central parity rate against the US dollar to make the renminbi exchange rate more flexible.

Though the move itself was correct, it triggered a sudden rise in expectations of renminbi depreciation. With that, capital began flowing out of China – and continued to do so through to the end of 2016. To shore up the renminbi, the PBOC burned through some US$1 trillion in foreign exchange reserves during this period.

In 2018, non-economic factors – specifically, rising tensions with the United States – became the main driver of capital outflows. From March 2018 to May 2022, the renminbi exchange rate fluctuated significantly, reflecting the shifting intensity of Sino-American tensions. For much of this period, the exchange rate hovered below the psychologically important threshold of 7 yuan per dollar.
The recent build-up of renminbi depreciation pressure began in May 2022, with the currency depreciating against the dollar at an unprecedented rate, again breaking the 7 yuan threshold in September.
This time, the main factor has been arbitrage activities, with investors seeking to take advantage of the widening interest rate differential between China and the US.

In the past, whenever the renminbi’s dollar exchange rate neared the 7 yuan threshold, some economists would warn that a collapse could follow if the threshold was allowed to be breached. This time, the PBOC has held firm in rejecting sustained intervention – and of course the crash has not come.

The PBOC’s response – a policy of “benign neglect” – is particularly laudable. Policymakers did lower the foreign exchange reserve requirement ratio for banks, and they persuaded commercial banks to support the renminbi in various subtle ways. But they did not intervene in the foreign exchange market in any significant way.

Now, external pressure on the renminbi is waning. This is partly because of developments in the US: inflation has fallen for four consecutive months, and, perhaps more important, central bankers seem to have realised that their aggressive monetary tightening – 75-basis-point rate hikes at four consecutive policy-setting meetings – is untenable.

In fact, at its last policy-setting meeting of 2022, the Fed raised interest rates by only 50 basis points. As market expectations for US interest-rate hikes wane, so does downward pressure on the renminbi.
A screen shows stock and currency exchange data on a building in Shanghai, on September 29. Photo: EPA-EFE

But the renminbi’s value is not decided by US central bankers. The currency retains a fundamental strength, rooted in market confidence in the Chinese economy. This time, renminbi depreciation has triggered no panic in China’s financial market, which reflects the maturity of Chinese investors and the market itself.

If Chinese growth can rebound strongly in 2023, net capital outflows will decrease or even reverse, providing further support to the renminbi. Beijing’s decision to abandon its zero-Covid policy makes this scenario more likely, not least because that policy constituted the most powerful constraint on the effective implementation of expansionary fiscal and monetary policy. The likely result will be a growth rate that is higher than previous market forecasts.

Whatever happens, the PBOC would do well to stick with benign neglect, allowing the exchange rate to act as an automatic stabiliser, while treating capital controls as the last resort. In other words, China’s government should focus on economic growth and let the market take care of the renminbi.

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright: Project Syndicate
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