Why is the Chinese central bank subsidizing the yuan
The Chinese yuan has fallen to a two-year low against the US dollar in the past few weeks.
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BEIJING – China’s central bank has sent a strong signal that it wants to prevent the Chinese yuan from weakening too quickly against the US dollar, economists said.
For the second time this year, the People’s Bank of China announced on Monday that it will reduce the amount of foreign currency that banks must hold.
Such moves in theory reduce weak pressure on the yuan, which has fallen more than 8% this year to its lowest level in two years against the US dollar.
Chinese authorities usually emphasize the level of the yuan against a basket of currencies, against which the yuan has strengthened by about 1% over the past three months.
However, Beijing’s recent actions show how important the yuan’s exchange rate against the dollar is, Nomura’s chief China economist Ting Lu and team said in a report Monday.
They gave two reasons:
- “First, in a year of once-in-a-decade ministerial change and with rising US-China tensions, Chinese leaders are particularly interested in the bilateral yuan-dollar exchange rate because they believe that the RMB/USD somehow reflects relative economic and political strength.
- “Secondly, a significant depreciation of the yuan/US dollar could dampen domestic sentiment and accelerate capital flight.”
China’s ruling Communist Party is due in October to choose a new group of leaders, with President Xi Jinping’s power cementing.
Tensions between the United States and China have risen in the past several years, resulting in tariffs and sanctions against Chinese technology companies.
Meanwhile, China’s economic growth has slowed in the past three years, especially with the shock of the epidemic in 2020. Tighter Covid controls this year, including a two-month shutdown of Shanghai, have prompted many economists to lower their GDP forecasts to nearly 3%.
This economic slowdown has weakened the yuan, which could help make Chinese exports cheaper for buyers in the United States and other countries.
The US dollar has strengthened significantly this year as the US Federal Reserve aggressively tightened monetary policy.
In addition, the US currency – according to the US dollar index – benefited from the lowest levels of the euro in 20 years and from a similar decline in the Japanese yen.
levels to watch
“We believe the People’s Bank of China (PBOC) may tolerate further depreciation of the Chinese yuan against the US dollar, especially as the broad US dollar continues to strengthen, although they may want to avoid a sustained and rapid one-way decline if at all possible,” he said. The team reported on Monday.
Analysts said they expect the yuan to depreciate to 7 per dollar over the next three months. Nomura foreign exchange analysts expect it to reach a level of 7.2 by the end of the year.
The yuan last traded near 7.2 against the dollar around May 2020 and September 2019, according to Wind Information data.
“I don’t think it will go much beyond that It definitely surpasses the kind of 7.2 we’ve seen during the trade war, Julian Evans-Pritchard, chief China economist at Capital Economics, said Tuesday on CNBC’s “Squawk Boxes Asia.”
“I think that’s the main threshold,” he said. “I think the reason they are reluctant to let that happen is that, if it goes above that level, expectations about currency risk will become unconstrained. You risk seeing much larger capital inflows.”
The People’s Bank of China on Tuesday set the midpoint of the yuan against the dollar at 6.9096, the weakest point since August 25, 2020, according to wind information. The Chinese central bank loosely controls the yuan by setting the midpoint for intraday trading based on recent price levels.
PBOC: Don’t bet on a point
The People’s Bank of China’s latest cut in the foreign exchange reserve ratio – to 6% from 8% – is set to take effect on September 15, according to an announcement Monday on the central bank’s website.
Earlier on Monday, Vice Governor of the People’s Bank of China (PBOC) Liu Guoqiang said that in the short term, the currency should fluctuate in two directions and people should not bet on a point.
This is according to CNBC’s translation of the Chinese version of Liu’s remarks at a press event on economic policy.
In the long run, Liu maintained Beijing’s hopes of increasing the use of the international yuan. “In the future, the world’s recognition of the yuan will continue to increase,” he said.
CNBC’s Abigail Ng contributed to this report.