China should seize the moment to free up controls on the yuan to expand its international use
- The dangers of capital outflow have eased as China’s economy has recovered rapidly from the impact of the coronavirus pandemic
- The yuan has become a safe bet for value due to a weaker US dollar, but Beijing still maintains tight control of capital flows
For the last five years, China’s central bank has been fighting to defend two key numbers: seven and three. Seven refers to the exchange rate between yuan and the US dollar – if the yuan weakens too much beyond seven to the US dollar, it would be regarded as a dangerous sign. Three refers to the level of China’s stockpile of foreign exchange reserves – if reserves dip below US$3 trillion, it would be seen as a sign of weakness.
The context for the unannounced campaign to defend the two key figures is a deep concern over the rapid capital exodus that occurred after the sudden change in perceptions about China’s financial health and economic robustness following a devastating stock market rout in the summer of 2015, and Beijing’s subsequent clumsy steps to devalue the yuan by nearly 2 per cent.
The restrictions on the ability of ordinary Chinese people to access foreign exchanges increased significantly, even though, on the surface, China maintains a policy that every citizen is entitled to buy up to US$50,000 worth of foreign currencies every year.
With a lopsided foreign exchange policy of encouraging inflows and discouraging outflows, China has achieved its goal of avoiding a large yuan depreciation or an exodus of funds.
But after five years of this defensive posture, there are signs that the tide could turn again.
With the US Federal Reserve’s aggressive monetary easing policy leading to a weaker US dollar, the yuan has become a safe bet for value.
The time is ripe for Beijing to free up controls on the yuan’s convertibility with other currencies.