With China’s yuan tipped to slide further against the US dollar, how much will Beijing tolerate?
- Analysts expect the yuan to fall further against the dollar, which could accelerate capital outflows without benefiting exports significantly
- China’s central bank is reducing the amount of foreign currency deposits banks need to hold, a move seen as aimed at slowing depreciation
Capital outflows from China are likely to accelerate as the yuan weakens, according to analysts, though the country’s central bank has signalled it has tools to prevent a sharp depreciation of the currency.
The yuan has been falling against the US dollar since April, losing 2.7 per cent over the past month alone. The weak currency, as well as rate increases from the US Federal Reserve, coronavirus lockdowns and Russia’s invasion of Ukraine have contributed to a record sell-off of Chinese stocks and bonds this year.
China recorded outflows of US$81 billion between February and July, according to data from the Institute of International Finance.
Still, analysts expect the yuan to continue sliding against the dollar, with the question now how much the PBOC will tolerate.
Wang Jinbin, vice-dean of the School of Economics at Renmin University of China, said letting the yuan slide past the key threshold of 7 per US dollar would not benefit exports significantly, but would exacerbate capital outflows.
If the yuan is allowed to weaken past 7 per US dollar, it could trigger “expectations of further depreciation” among companies which could cause disruption in the exchange market, he said.
Key imports in energy and food would also become more costly if the yuan continued to slide, Wang said, adding the PBOC should consider all policy tools to slow depreciation.
The exchange rate of the onshore yuan closed at 6.9485 per US dollar on Tuesday, slightly weaker than Monday’s close of 6.9366.
Traditionally, an exchange rate between the yuan and dollar of 7-to-1 has been considered a key psychological barrier. But consultancy Gavekal Dragonomics said on Tuesday the threshold is no longer as important to Chinese currency traders, as it has been broken twice in recent years.
The PBOC now tolerates more depreciation, which allows automatic adjustment to the historically strong dollar, said Wei He, China economist at Gavekal.
“Given that China is already dealing with substantial capital outflows, the PBOC is unlikely to risk a bigger depreciation that would push down the trade-weighted exchange rate,” said Wei.
PBOC deputy governor Liu Guoqiang said on Monday the yuan has shown more flexibility and that two-way fluctuations over the short term are normal.
“Basic stability is what we like to see,” Liu said. “We have the strength to support [the yuan], and I don’t think anything will happen. Nor will anything be allowed to happen.”
UOB Group said on Tuesday the PBOC’s priority will remain stabilising the economy, as well as preventing sharp currency depreciation ahead of the 20th party congress next month.
“To further stem depreciation, the PBOC may also increase offshore bill issuance to absorb the offshore yuan liquidity,” UOB Group said in a note.
“In other words, the PBOC is in a bind: it needs to cut rates to support the economy but faces too many constraints to do so. Thus, we expect the rate cut in the remainder of 2022 to be only moderate,” Natixis said.