China’s currency is showing signs of weakening against the U.S. dollar. While the economy’s condition is growing gloomier, it’s likely that the Chinese yuan will experience a decline in value, but a sharp and sudden drop shouldn’t be anticipated.
China’s exports are declining
Despite maintaining a substantial trade surplus, China is witnessing a decline in exports, causing this surplus to shrink. The Chinese central bank is adopting more aggressive easing measures in response to the economic slowdown. Meanwhile, the U.S. continues to maintain higher interest rates, and there is a growing belief that the U.S. economy will experience a gradual and controlled slowdown, ensuring that these elevated rates may persist until the following year.
Following an initial economic recovery after reopening, China’s economy is now grappling with a challenging phase. Economic indicators from July, including retail sales, industrial production, and investment, have all fallen short of expectations. The housing market is also experiencing a renewed deterioration, with liquidity concerns emerging at Country Garden, a prominent surviving property developer. Additionally, after a brief surge in the spring, exports are now declining faster than imports.
Simultaneously, the gap between interest rates in the United States and China continues to widen. China’s central bank implemented reductions in two crucial policy rates on Tuesday, with predictions from Nomura suggesting further cuts within this year. Presently, the difference in rates between 10-year government bonds from China and the U.S. stands at 1.7 percentage points, a notable increase from approximately 1 point at the start of the year. This alteration becomes even more significant when considering real terms, as U.S. inflation has substantially declined in 2023.
Chinese yuan receiving pressure from the falling economy
This situation is exerting pressure on the Chinese yuan, hovering around 7.28 against the dollar, marking a decline of roughly 5% over the year. Notably, the yuan traded offshore reached 7.34 against the dollar on Thursday. If the onshore yuan were to mirror this trend, it could record its weakest official closing rate since the period preceding the global financial crisis 2008. Both the onshore and offshore yuan experienced a strengthening following the announcement from the People’s Bank of China on Thursday evening, affirming its commitment to preventing excessive fluctuations in the currency and maintaining a broadly stable exchange rate.
There are limited indicators of the extensive capital outflows and substantial declines in reserves that characterized China’s currency predicament in 2015 during the previous significant property market downturn. However, there are indications that pressures have increased marginally, and the central bank has intensified its efforts to counteract depreciation.
China’s official foreign reserves are flat for the year. But data provider CEIC shows banks’ actual net foreign-exchange sales, arguably a better indicator of outflow pressure, came to nearly $15 billion in July, the highest since March and second highest since 2019.
Furthermore, the People’s Bank of China has adopted a more assertive approach by utilizing its administrative mechanisms, including the daily “central parity rate” that sets the baseline for the yuan’s permissible fluctuations, allowing a range of up to 2% in either direction. The divergence between the yuan’s official daily closing rate and the central parity rate has expanded to around 0.1 yuan, a level last observed in late 2022 during China’s Omicron outbreak.
Recent days have witnessed a surge in short-term yuan-borrowing rates in Hong Kong, potentially signaling that regulators have taken measures to increase the cost of speculating against the offshore yuan.
Meanwhile, a weaker yuan could provide substantial benefits to China, particularly since costs related to food and energy have experienced declines while the country’s exporters are grappling with challenges. However, the fear of substantial capital outflows triggered by an unforeseen depreciation of the yuan, as was the case in 2015, continues to linger in Beijing’s considerations. Between 2014 and 2016, foreign reserves diminished by approximately $1 trillion.
Given this, it is likely that Beijing will persist in countering rapid depreciation by employing administrative strategies and tactics to penalize speculators. Additionally, as circumstances demand, intervention may moderate the decline rate, utilizing a portion of its substantial foreign reserves or foreign assets held within state-owned banks, which amount to $3.2 trillion. China’s capital controls, bolstered after the 2015-16 crisis, will also assist these efforts, particularly concerning overseas property and direct investments.
Although the yuan is projected to undergo further devaluation, a pronounced and sudden plunge would indicate either heightened desperation, akin to the situation in 2015, or a failure in the effectiveness of capital controls. While both scenarios are improbable, they would undoubtedly cause serious concern.
Source: https://www.cryptopolitan.com/chinese-yuan-is-weakening-against-usd/