US Fed rate hike: how can China stem capital outflow and prop up the yuan?
- As US central bank announces its sharpest rate increase in 22 years to address decades-high inflation, analysts speculate on how Beijing will try to soften the economic blow
- People’s Bank of China has a number of tools at its disposal, and extent of intervention will play a role in whether GDP growth goals are achievable
One of the external headwinds that China’s economic policymakers have been warning about has materialised, with the US Federal Reserve announcing its sharpest interest-rate hike in more than two decades.
The Fed’s move on Wednesday – raising the benchmark interest rate by 50 basis points to a target rate range of between 0.75 and 1 per cent – was expected, and it will be followed by further tightening later this year.
Tan Yaling, head of the Beijing-based China Forex Investment Research Institute, said that an acceleration in capital outflows – the result of US Treasury bond yields surpassing those of Chinese bonds – could be partly offset if Beijing strengthens its regulation of the forex market and steps in to prevent excessive depreciation of China’s currency.
“The yuan is not a fully convertible currency,” she said. “Forex controls should be put in place when necessary. They are all for the sake of [financial] security.”
Overseas investors had already slashed their holdings of Chinese bonds and equities by 112.5 billion yuan in March, after selling 80.3 billion yuan worth a month earlier.
UBS chief China economist Wang Tao forecast on Wednesday that the yuan’s exchange rate could reach 7.0 against the US dollar at some point, but may settle at around 6.9 by year’s end, amid the US monetary policy tightening. A higher yuan exchange rate figure means it takes more yuan to purchase one US dollar, indicating a weaker Chinese currency.
Wang also pointed out that China’s central bank is looking to slow the depreciation momentum.
“It has other means to control depreciation, including cutting the reserve requirements further, reintroducing the countercyclical factor in its daily fixing and tightening controls on capital outflows,” she wrote in a research note.
Ding Shuang, chief Greater China economist at Standard Chartered Bank, also noted that Beijing has many reserve tools to manage outflows and defend the yuan, but interest rate hikes in the US will weigh heavy on Beijing’s ability to cut the reserve requirement ratio (RRR) and policy rates.
“We are expecting, at most, one cut of the medium-term lending facility for this or next month, but the window is closing under the monetary policy divergence,” he said.
Ding said the PBOC tends to primarily use quantitative tools and some “concealed” rate cuts to help accomplish the country’s growth targets.
For instance, the central bank set the relending rate on the quota for logistics, coal and technological innovation at 1.75 per cent, lower than the 2 per cent rate for existing quotas for small business and the agriculture sector.
Meanwhile, it has pushed state-owned banks to lower the deposit-rate ceiling – a move that will create more room for funding rate cuts.
“The policymakers tend to avoid headline rate cuts, in case capital outflows accelerate,” Ding said.
Meanwhile, he said: “Beijing should beef up policy support, but it should also consider fine-tuning its pandemic-control measures. Fiscal and monetary stimulus won’t work well if economic activities can’t be started as normal.”
The US Fed’s rate hikes make China’s gross domestic product (GDP) growth goal even more difficult.
External shocks are being amplified amid market concerns over weakened economic fundamentals, including the plunge in retail sales against a background of rigid lockdowns in some large cities, supply-chain disruptions, and price inflation during the Russia-Ukraine war.
And as the promised support from the Politburo, China’s cabinet, has yet to unfold, domestic economic figures continue to deteriorate, triggering louder calls to prioritise domestic growth and adjust the rigid implementation of zero-Covid efforts.
Another reason for capital outflows is “growth expectations”, warned Alicia Garcia Herrero, Natixis’s chief economist for the Asia-Pacific region, at a webinar on Thursday.
She estimated that China’s GDP growth was trending lower based on lost mobility amid lockdowns, echoing the growth downgrades recently made by international investment banks, which are currently estimating that GDP will grow between 4 and 4.5 per cent this year.
Tan endorsed the central bank’s choice of structural support, saying across-the-board stimulus measures would not provide sufficient financing for the hardest-hit sectors.
“We need to ask where the 530 billion yuan worth of liquidity will go. The destination of such funds is very important,” she said, referring to the amount of long-term liquidity that the central bank released into the interbank system on April 25 via its RRR cut, with an aim of supporting the economy in the face of growing headwinds.
“The central government should consider offering more supportive policies to help vulnerable small and medium-sized enterprises, such as transferring some profits of large state-owned enterprises to affected sectors, or slightly easing the pandemic-control measures.”