MNI INTERVIEW: Yuan Within Wider Band- Former SAFE Official

The yuan will likely fluctuate in a wide band for the rest of 2023, as China’s bumpy economic recovery underwhelms and weaker-than-expected policy stimulus weighs on the currency, though it is likely to eventually strengthen back below 7 to the dollar should economic recovery strengthen, a former director general of balance of payments at the State Administration of Foreign Exchange told MNI.

Both the onshore CNY and offshore CNH rates broke 7.0 to the U.S. currency last week for the first time in five months, continuing a rapid depreciation first noted in mid-April. The onshore yuan has now depreciated roughly 1% from the end of 2022 and 5% from its strongest point this year at 6.7. (See MNI: Yuan Supported By Rebound But Firm USD Risks Move Above 7)

Guan Tao, now global chief economist at BOC International, attributed the recent weakness to April’s disappointing economic data and dollar strength, saying a “basic scenario” of volatility within a relatively wide band with a bias towards appreciation remains more likely than either sustained weakness or strength.

“While the market is divided on the steepness of the recovery, there is consensus that China’s economy will still pick up as its counterparts face a risk of recession, which will support the yuan,” he said. “There is no fundamental basis for a one-way, continuous depreciation of the yuan… It is too early and too risky to bet on a soft momentum for the yuan at present.”

Positive yuan factors include a current account surplus, despite a growing deficit in services trade, while capital outflows will ease as foreign investors increase exposure to China’s equity market, Guan explained. Overseas direct investment also recorded net inflows last month, he added.

BACK BELOW 7

Guan said the onshore yuan could strengthen below CNY7 should the recovery gain momentum. He estimated whole-year GDP would grow by over 6% and Q2 would record an expansion of over 8.2%.

“It will not surprise if the yuan rebounds by about 5% from the current level if economic growth proves steady,” he said. “But we should watch the risk of a temporary depreciation due to deteriorating sentiment triggered by weaker-than-expected economic indicators.”

The PBOC warned last Friday it would crack down on pro-cyclical and one-way bets on the yuan rate when necessary and curb speculation to prevent excessive volatility as USDCNY approached CNY7.1.

“Any intervention will ease volatility and buy time for markets to make self-adjustments,” Guan said. He added that USDCNY had broken CNY7 four times since 2019 and each time recovered within months.

The PBOC has plenty of tools to curb excessive yuan weakness, such as deploying its foreign reserves or strengthening capital controls as well as trying to talk the currency higher. But the use of such tools has drawbacks and should be carefully considered, said Guan, who has been a prominent proponent of a more flexible exchange rate to cushion the economy against domestic and external uncertainties. Any move to peg the currency would only encourage speculation, he noted.

MONETARY OUTLOOK

The PBOC’s monetary policy also has its limits, he said, adding that the central bank will be cautious before any further easing, which could make a return to more neutral policy stances more challenging. It is also unrealistic to expect the PBOC to continue to provide the same levels of stimulus as in the first quarter, now that the M2 measure of money is jumping by 12.7% y/y, the fastest level since May 2016, and the macro leverage ratio gained 8.8pp in Q1 from the end of 2022.

The PBOC’s 17 targeted facilities increased by CNY375.4 billion in Q1, representing 89% of its total balance sheet expansion.

Still, authorities should do more to boost consumption, which would in turn fuel investment, Guan said, noting that the government’s lower-than-expected 5% growth target set during the Two Sessions meeting in March was formulated with the expectation that China’s Covid recovery will not be smooth.