China’s policy makers are facing a tough call on where they want the yuan to stand as the tightly-controlled currency hits a seven-month low against the US dollar, approaching its weakest level since 2008.
A weaker yuan could help boost exports and bring inflation to the economy but risks undermining President Xi Jinping’s ambitions to make it a global currency.
On June 21, the People’s Bank of China set the daily fixing—a benchmark where the currency is allowed to trade —at 7.1196 against the dollar, the weakest since November 23. Pan Gongsheng, the governor of PBOC, told a major financial forum in Shanghai on June 19 that the exchange rate has “maintained relative stability in a complex environment.” The central bank will “maintain exchange rate flexibility” using the fixing.
But foreign investors are overwhelmingly predicting a softer yuan by the year-end, as expectations for a US Federal Reserve interest rate cut scale back. Earlier this month, the Fed kept interest rates at the highest level in more than two decades and officials projected only one rate cut this year.
The PBOC also kept its benchmark rate steady this month, but some economists expect the central bank to loosen monetary policy as it battles a property market downturn. Offshore demand for Hong Kong dollars from Chinese companies for dividend payouts to prop up much-beaten-up share prices are also putting pressure on the yuan.
The onshore yuan on June 21 fell to 7.2613 against the dollar, edging closer to the upper limit of the plus or minus 2% that it is allowed to fluctuate against the daily fixing. That’s the lowest level since November. If the yuan falls past the 7.3498 recorded on September 8, 2023, it will be a new low since 2008. The offshore yuan, which trades more freely, hit a fresh year-to-date low of 7.2926 against the dollar.
While Asian currencies are suffering with the strong dollar, one thing is unique to the Chinese currency. The upcoming US election escalates geopolitical uncertainty around holding yuan assets. In particular, investors are nervous about potential additional tariffs being put on Chinese goods if former US president Donald Trump gets reelected.
“We remain bearish on the Chinese yuan,” said Kiyong Seong, lead Asia macro strategist at French bank Societe Generale, which predicts the yuan will fall to 7.4 against the dollar in the third quarter. A fall to that level would bring the currency to its weakest level since December 2007. The call reflects concerns about geopolitical headwinds brought by the US election, Seong said. The PBOC is likely to continue with the current “surgical management” of the currency for the rest of the year, however, he added.
Cheuk Wan Fan, Asia CIO for HSBC private bank, and Leonard Kwan, a portfolio manager at US asset manager T Rowe Price, also predict a weaker yuan this year, when asked about their views recently by Nikkei Asia.
A weak yuan would help stimulate exports and help generate inflation pressure for China in the form of higher import costs. Those two forces are actually what the economy needs, said Michelle Lam, greater China economist at Societe Generale. China’s consumer price index in May rose 0.3% year on year, unchanged from April, indicating persistent deflationary pressures.
“But I don’t think that’s what the policymakers want,” Lam said, citing Chinese President Xi’s agenda for a stronger yuan to push for internationalization of the Chinese currency. “Whether it works in the long term, it’s debatable. But I don’t think they also want a weakening currency.”
China’s exports and imports grew in the most recent two months. The country’s trade surplus stood at USD 82.62 billion in May, up from April.
A weaker yuan may further escalate trade tensions with the US and Europe. The European Union recently announced additional import tariffs of up to 38% on EV imports from China, prompting Beijing to launch an anti-dumping investigation into imports of EU pork.
Ken Cheung, director of FX strategy at Mizuho Securities in Hong Kong, said China may be “more tempted to consider allowing further [yuan] depreciation to counter impact from the potential tariff hikes,” even though he believes any policy-driven depreciation will likely be gradual.
The episode of the weak yuan in 2015 has induced capital outflow pressure, Lam said. “And I think that is really what policymakers want to avoid right now.”
Any drastic depreciation of yuan could risk exacerbating the capital outflows. Back in 2015, when China’s central bank devalued the yuan, it sent shocks to the global currency market, driving down the South Korean won and the Australia and Singapore dollars.
Today, China’s rich are also looking to diversify their assets overseas under the push of low-yielding yuan-deposit rates, a disappointing stock market performance, and wealth destruction in a property market which has yet to respond to the latest policy push. Hong Kong dollar bank deposits and insurance savings products have been popular choices for mainlanders.
China’s central bank is managing the currency via more routes instead of relying on using the foreign exchange reserve, a series of methods are being deployed in a more strategic way in order to avoid a big depreciation that could shock the market. But these measures are also making it harder for investors to gauge potential impacts.
Onshore banks were selling spot dollars for yuan and swapping into one-year forwards in September when the Chinese currency underwent big depreciation pressure, Nomura analysts led by Craig Chan wrote in a note on May 28. Now, the concern is if banks will roll these swap positions, especially at a time when they may need to borrow dollars, which actually creates demand for the greenback. “September may mark the beginning of pressure on major banks,” the analysts said.
Some are taking a more defensive view. Becky Liu, head of China macro strategy at Standard Chartered Bank, predicts the yuan to trade at 7–7.1 against the dollar approaching the year-end, citing a “smaller” short position of yuan compared to the second half of 2023.
“I am not aware of who’s really having a gigantic position [shorting the yuan]. So everyone has a little bit of a position to express their view,” Liu said. China’s incentive and ability to defend the currency remain “very strong,” she said. But she also cautions that potential tariff policies brought by US election could put headwinds on the currency.
“There is an orderly weakening in the currency,” said Owen Murfin, institutional portfolio manager at US asset manager MFS. “I think it’s justified by fundamentals, it helps exporters. So I don’t think authorities will be too concerned about an orderly devaluation of the [yuan], which is another reason why we are pretty defensive on the [yuan] right now.”
This article first appeared on Nikkei Asia. It has been republished here as part of 36Kr’s ongoing partnership with Nikkei.