China’s Weakening Currency Is Becoming a Headache for Its Central Bank
By Weilun Soon, July 5, 2023, WSJ
China’s currency has weakened too far and too fast for its central bank.
The onshore yuan, also called the renminbi, has lost around 4.8% of its value since the start of the year, according to FactSet. A dollar on Wednesday bought 7.2432 yuan in mainland China, a rate that is heading toward a 15-year low set last November.
The more freely traded offshore yuan was at 7.2542 per dollar, according to FactSet.

The People’s Bank of China has started to respond, repeatedly setting a key daily reference rate at levels that defy market expectations. Economists use the yuan’s daily fixing as a gauge of how much the central bank is taking action to influence the
yuan. A day earlier, the currency was fixed at 7.2046 against the dollar, which analysts said was the biggest divergence this year from what markets were expecting.

“The yuan’s weakness has gotten to a stage where they felt it’s overdone and therefore they have started to step in to send a clear signal that they are reining in the depreciation,” said Khoon Goh, ANZ’s head of Asia research.

The central bank’s response to the yuan’s recent weakness shows the delicate balancing act that will confront Pan Gongsheng, who is set to become the next governor of the People’s Bank of China.

The onshore yuan weakened past 7.30 against the dollar in November 2022, and the offshore yuan traded at its lowest-ever level then. The PBOC took a series of steps to prop up the value of the currency, including making it more expensive for companies in
China to borrow foreign currencies. It now faces the choice over how far to go this time.

The PBOC has pledged to “resolutely guard against the risk of sharp fluctuations in the exchange rate,” according to minutes of its second-quarter policy meeting that were released last Friday. That phrase didn’t appear in its minutes for the
previous quarterly meeting. The central bank didn’t respond to a request for comment.

Last week, when the offshore yuan briefly weakened past 7.28 per dollar, an article in a state-run newspaper overseen by the central bank said the yuan’s exchange rate “has solid fundamental support” and should remain at a stable level in the
second half of the year.

It also warned against currency speculation. “Do not bet on the appreciation or depreciation of the renminbi. If you gamble for a long time, you will lose,” the article said.

China’s economic recovery is losing steam, with recent data on manufacturing, new home sales and employment all showing how difficult it is for the economy to bounce back from a long and painful series of restrictions to fight Covid-19. China’s
exports in May were down 7.5% from a year earlier, despite the fact that in May 2022 the country was still in the midst of its strict zero-Covid policies.

The PBOC surprised the markets last month by cutting interest rates, which economists at Standard Chartered said was “a clear signal of easing intended to prevent negative sentiment feeding on itself.”

But the cut further increased the difference in interest rates between China and the U.S., which has been one of the big drivers of yuan weakness over the past year.

The Federal Reserve took a pause last month after 10 consecutive interest-rate increases. Although Fed officials have indicated they are likely to lift rates further, most economists think they are near the end of the raising cycle. That will help
stabilize the yuan later this year, according to analysts and economists.

The yuan’s weakness has been exacerbated recently by foreign investors pulling money from mainland China’s stock market. More Chinese exporters are also choosing to hold on to U.S. dollars and other foreign currencies rather than convert them into
yuan, removing one source of support for the currency.

Unlike many Western central banks, the PBOC has a wide brief, being tasked with managing inflation, keeping the currency stable and managing risks in the financial system. It has secondary aims of boosting economic growth and employment.

These goals aren’t always compatible. An obvious solution to weak exports is a weaker currency, which would make Chinese goods cheaper for the rest of the world. But the central bank’s desire to keep the yuan stable makes that difficult.

Chinese central bankers’ reluctance to let the currency weaken further is partly because they worry about a wider fallout, including the impact on property prices, the stock market and even questions about the Hong Kong dollar peg, said Ligang Liu,
head of Asia-Pacific economic analysis at Citi Global Wealth Investments. Hong Kong’s currency is allowed to trade in a range against the dollar, although the permitted levels remain close to the yuan’s value against the dollar.

The central bank monitors the performance of the yuan against a basket of currencies, including those of some of China’s largest trading partners in Asia. A sudden depreciation would hurt its trade relations with those countries and drag regional
currencies lower, said Sim Moh Siong, currency strategist at Bank of Singapore. “That may then feed back into China and the overall perception of Chinese markets,” he said.

The fate of China’s economy may be largely out of the PBOC’s hands in any case, according to economists.

“If we look at the root cause of the weakness of the economy, it’s not the lack of liquidity, it’s not about the affordability of the credit, it’s not about the availability of credit—it’s just a lack of confidence,” said Shuang Ding, a
senior China economist at Standard Chartered.

https://www.wsj.com/articles/chinas-weakening-currency-is-becoming-a-headache-for-its-central-bank-372ec31d

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