By Wei Hongxu*
With China relaxing entry restrictions, and the peak of the COVID-19 pandemic gradually passing, the prospect of China’s economic recovery is becoming more and more optimistic. This brings the exchange rate of the Chinese yuan, or renminbi (RMB) against the USD to continue to strengthen rapidly at the beginning of the new year. After a lapse of nearly 5 months, both the onshore and offshore RMB/USD exchange rates regained the 6.8 mark. As of the close on January 9, the onshore RMB/USD exchange rate was at 6.7712, an increase of 876 basis points from the previous trading day. The central parity rate of the RMB against the USD was quoted at 6.8265 that day, the highest since August 22, 2022, which was an increase of 647 basis points. During the trading period of more than a week in 2023, the RMB exchange rate has appreciated by more than or close to 2%, reaching a level rarely seen in history.
Calculated from when the RMB exchange rate started to strengthen in November last year, the current exchange rate has both risen above the 6.8 mark and returned to the level before August last year, with an appreciation rate of about 7%. Some institutions are more optimistic about changes in this. Foreign investment banks including Goldman Sachs and Morgan Stanley also predict that the RMB exchange rate will appreciate to around 6.5 in 2023. The positive significance of this change is that it reflects the optimistic expectation of China’s economic fundamentals, which is conducive to attracting foreign capital inflows and promoting the recovery of China’s economic growth.
However, looking at the trend, on the one hand, the weakening of external demand in foreign trade may lead to a decline in exports, resulting in a continued narrowing of the current account surplus. On the other hand, although the Federal Reserve’s policy has become clearer, the interest rate differential between China and the United States will still put pressure on the RMB exchange rate. That being said, the uncertainty of the U.S. economic outlook and the changes in the USD index cannot be ruled out, and this is disadvantageous to the continued appreciation of the RMB exchange rate. Therefore, the unilateral appreciation of the RMB exchange rate may be difficult to maintain for a long time, and the future will still be a trend of bilateral shocks.
Researchers at ANBOUND mentioned not long ago that in 2023 when the external trend becomes clearer, the RMB exchange rate will be more affected by internal factors. If the Chinese economy gradually recovers as expected, the exchange rate may rise amid fluctuations. This recovery is actually the return of the Chinese currency to a reasonable equilibrium. However, ANBOUND has also previously warned that the change in the RMB exchange rate should not deviate from the rational range. Excessive appreciation or depreciation will bring about a volatility correction. The farther the deviation, the stronger the correction will be. The two-way fluctuation of the RMB exchange rate in 2023 will still be the norm. Therefore, the rapid rise of it is not entirely beneficial to China’s economic and financial stability during the recovery period.
Judging from the situation in 2022, the RMB exchange rate has already experienced huge fluctuations. According to previous calculations by researchers at ANBOUND, the cumulative depreciation of the RMB against the USD in the offshore market last year was about 8.63%, the largest annual decline in recent years, and the fluctuation range exceeded 16% compared with the value at the beginning of the year. The central parity rate of the RMB against the USD has depreciated by 5889 basis points throughout the year, with a depreciation rate exceeding 9.23%, which is also the largest depreciation rate since the “8.11 exchange rate reform” in 2015. Such large fluctuations affect the expectations of the economy and the valuation of RMB asset prices. This, in turn, brings about rapid capital flows, as well as disturbances to the capital market and foreign trade.
With the Fed’s tightening policy tending to ease, the USD index has begun to fall from its high level. The USD has depreciated to varying degrees against major currencies such as the Japanese yen and the euro. This means that international capital has begun to overflow from chasing dollar assets to emerging markets and other regions that still have growth potential, seeking to obtain additional exchange rate benefits while obtaining investment profit. Judging from the current situation that international investment banks are optimistic about RMB assets, international capital has begun to flow into the country and is deploying in advance. Although this is beneficial to the recovery of the Chinese capital market and can lead to an increase in asset prices, it will also increase the bubble in the country’s domestic asset prices, including real estate, which will bring greater volatility and risks.
At the same time, the rapid appreciation of the RMB exchange rate is also detrimental to the Chinese economy. On the one hand, this will affect foreign exports, which are already facing the pressure of a huge decline in external demand, and will accelerate the transfer of global supply chains overseas. On the other hand, an excessive appreciation of the RMB will also increase domestic inflationary pressures. Researchers at ANBOUND have noted that, under the new situation, neither excessive depreciation nor appreciation of the RMB exchange rate would be conducive to the stability of the economy. Therefore, the view that the appreciation of the RMB is conducive to economic growth has considerable limitations. Like the risk of excessive depreciation of the currency, excessive appreciation of the RMB is also not advantageous in ensuring stability and the recovery of the Chinese economy. Hence, maintaining the stability of the RMB exchange rate is still one of the main components of monetary policy.
Final analysis conclusion:
In the new year, the RMB exchange rate showed a trend of rapid recovery. This has a positive effect on improving market expectations and promoting capital inflows. However, just like the rapid depreciation, the rapid appreciation of the exchange rate that deviates from the reasonable range also poses certain risks to China’s economic and financial stability. Maintaining the stability of the RMB is not only the goal that the country’s monetary policy needs to adhere to but also the basis for achieving stable growth and economic recovery.
Wei Hongxu is a researcher at ANBOUND