China’s yuan breaching key level of 7 per US dollar for first time in over 2 years creates quandary for Beijing
- Onshore yuan opened at 7.0054 on Friday from Thursday’s close of 6.9775 having last weakened to 7 per US dollar in July 2020
- Analysts attribute the weakening of the yuan to the fast strengthening of the US dollar, with the US Federal Reserve also set to announce a further interest rate increase
China’s yuan breaching the psychological threshold of 7 per US dollar for the first time in more than two years has triggered speculation over whether and how the central bank should intervene.
Analysts largely attribute the weakening of the yuan to the rapid strengthening of the US dollar with its index rising by 14.3 per cent so far this year, reaching a 20-year high, amid the belief Beijing will not respond and change its policy course immediately.
The looming decision by the US Federal Reserve whether to further increase interest rates next week adds another layer to Beijing’s predicament as it aims to maintain financial stability ahead of the 20th party congress next month.
“The strengthening of the US dollar index is the direct reason for this round of yuan depreciation. It was also dragged by higher US bond yields than Chinese ones and concerns over economic slowdown,” said Ping An Securities analyst Wei Wei.
“In the short term, we believe the US dollar will remain strong. In the light of the divergence – loose domestic liquidity versus external tightening – and the weak domestic economy, depression pressure on the yuan exchange rate will continue to exist.”
Wen Bin, chief economist with China Minsheng Bank, said the yuan’s weakening was mainly due to the US Federal Reserve’s fast monetary tightening to combat high inflation in the United States, and the subsequent strengthening of the US dollar index.
“There’s no basis for a persistent depreciation,” he said.
The People’s Bank of China had earlier on Friday chosen to shore up market sentiment by setting the yuan’s midpoint at 6.9305 per US dollar, compared with 6.9101 a day earlier. The onshore spot yuan can trade within a 2 per cent range on either side of the midpoint.
The yuan’s depreciation against the US dollar, despite being much smaller than that of other currencies, is one of headwinds facing the world’s second-largest economy ahead of the 20th party congress next month.
In addition to the risk of a global recession and a domestic economic slowdown, the fast tightening by the US Federal Reserve – the US central bank has already rolled out a cumulative total of 225 basis points worth of interest rate increases since March – could soon see a higher US interest rate than the current one-year medium-term lending facility rate of 2.75 per cent in China, which could lead to capital outflow.
The US Federal Reserve is widely expected to increase interest rates by 75 basis points next week after US inflation remained at a high level of 8.3 per cent in August.
China, which has slashed its policy rate twice to help the coronavirus-battered economy, has seen outflows of portfolio investment for most of the year.
Foreign investors dumped 80 billion yuan (US$11.5 billion) of Chinese interbank bonds in February and 110 billion yuan in March, with the reduction between February-August totalling 590 billion yuan, according to China’s central bank.
Massive sell-offs of Chinese equities were reported through the Stock Connect programme with Hong Kong, while the yuan exchange rate weakened quickly after the US Federal Reserve’s first rate increase in late March.
Beijing has said it is better positioned and more prepared than during the capital exodus in 2015 which followed a sharp devaluation of the yuan and led to the tightening of capital controls to stem the outflow.
Its optimised foreign debt structure, higher foreign exchange hedging usage among exporters, a strong reserve position and its unique capital control measures are all in its favour this time, Beijing insists.
The nation’s foreign exchange reserves, despite shrinking by US$166.8 billion in the past seven months, remain the world’s largest at US$3.05 trillion at the end of August.
Wang Chunying, deputy director of the State Administration of Foreign Exchange, said the performance of the yuan exchange rate has been relatively stable compared to other major currencies.
The yuan has weakened by around 10 per cent against the US dollar so far this year, compared to a fall of around 12 per cent against the Euro, 15 per cent against the British pound and 20 per cent against the Japanese yen.
The official CFETS index, which measures the Chinese currency’s exchange rates against a weighted basket of currencies, has weakened by only 0.4 per cent so far this year.
“As the market-oriented adjustment mechanism becomes more mature, and the forex market players become more rational, China’s ability to counter external changes will improve further,” Wang said.
Corporate settlement of the US dollar will also rise towards the end of the year, which will help offset the depreciation pressure, added Wei from Ping An Securities.