After rebounding at the beginning of the month, the Chinese renminbi (RMB) exchange rate has recently fallen into a downward trend yet again. On October 21, the onshore exchange rate of the RMB against the U.S. dollar fell to the level of 7.2494, breaking through the low of 7.2458 in late September and hitting a new low since mid-January 2008. The exchange rate of the offshore RMB against the USD which reflects the expectations of international investors fell below the 7.28 mark at one point on October 21, but then rebounded quickly and closed at the level of 7.2294. Despite the rapid recovery at-the-close order, there is still the possibility of further decline in terms of overall performance.
Figure: Changes in Offshore RMB Exchange Rate and USD Index
Source: Investing.com, chart plotted by ANBOUND
The situation this year shows that the continuous depreciation of the RMB is closely related to the ongoing tightening of the Federal Reserve's policy. The Fed has already hiked the interest rates from 0%-0.25% to 3.0%-3.25% this year and may reach levels of 4.5%-4.75% this year, and possibly 5% or more next year. This policy trend has led to a constant rise in the USD index, which has now reached around 112 and may further rise to 120 within this year. With the widening of policy differences between countries, the world's major currencies like the euro (EUR), the yen (JPY), and the pound (GBP) will inevitably depreciate. As China's monetary policy of the RMB remains prudent, the increase in the interest rate gap between China and the United States will also lead to the depreciation of the RMB exchange rate. The performance of the RMB is no worse than that of other major currencies. Since the beginning of this year, the RMB has maintained a trend of appreciation against the JPY, the EUR, and the GBP. The RMB exchange rate index has also remained stable recently. On the whole, the RMB exchange rate relative to a basket of currencies is still rather stable. Therefore, the continuous depreciation of the RMB against the USD this year has not caused major fluctuations domestically, as other major currencies have shared the external pressure brought about by the appreciation of the USD to a certain extent.
Whether it is the last round of devaluation in April or the current devaluation since August, this will have a certain impact on the stock and bond markets. Among them, the Shanghai Stock Exchange fell below the 3,000-point integer mark twice, and the interest rate of China's 10-year treasury bond was adjusted by about 10BP. The revaluation of assets caused by the devaluation of the RMB also makes capital display the tendency to outflow to a certain extent. In addition, the continued slowdown of the Chinese economy since the second quarter has also caused the outlook for the RMB exchange rate to be less than optimistic. Although China still has huge foreign exchange reserves, the weak economic growth and the decline in corporate profits have affected the value of RMB assets. It also makes the negative impact of the devaluation of the RMB to be greater than the benefits brought by the decline in export costs. Furthermore, there is a drop in external demand, which also constitutes a fundamental constraint on China's foreign exports. Considering the current real estate market downturn in the country, there is difficulty in boosting the demand. The unstable exchange rate, in conclusion, is not conducive to the stability of China's economy as a whole.
Researchers at ANBOUND pointed out that in the case of the Fed continuing to raise interest rates, the Chinese economy will feel increasing external pressure, where maintaining the autonomy of domestic monetary policy will inevitably bring about fluctuations in the RMB exchange rate. As the Fed does continue to do so, it is expected that the RMB will continue to depreciate in stages. The depreciation trend of the RMB can only be reversed when the Fed's interest rate hikes come to an end and the U.S. economy shows a decline or recession. Chan Kung, the founder of ANBOUND, noted that this signifies that it is also possible for the RMB 8 to USD 1 exchange rate to take place. Therefore, in the case of exchange rate fluctuations, the People's Bank of China (PBoC) still needs to take periodic interventions to avoid panic selling caused by unilateral trends.
This pressure will, to a large extent, restrict China's space for implementing an independent monetary policy. At present, the LPR quotation for October has been released, which has remained unchanged for two consecutive months. This is not only caused by insufficient domestic demand but also by the fact that the U.S.-China interest rate gap has gradually widened. In fact, the LPR was lowered more than expected in August. Despite the consideration of serving the recovery of the Chinese economy and reducing the financing cost of the real economy, it actually started a new round of depreciation of the RMB against the USD. Although many market participants still hope that the LPR interest rate will continue to be lowered, the future interest rate policy needs to balance the external impact of the interest rate decline. Under the circumstance that the RMB exchange rate continues to fall, continuing to cut interest rates will cause it to face more severe external shocks. In view of this, short-term readjustment of interest rates and further loosening of monetary aggregates are not feasible and are likely to cause unexpected fluctuations in the RMB exchange rate. The overall effect may not be beneficial to the country's economic recovery.
Judging from the current trends, reducing interest rates and maintaining exchange rate stability has increasingly become a sort of "mission impossible". The increase in China's domestic interest rates will also have an important impact on the stability of the real estate market and the operation of Chinese enterprises, which could bring panic effects. As the Chinese economy remains still weak, the adverse consequences caused by the devaluation of the RMB exchange rate need to be considered. Under this circumstance, although monetary policy still emphasizes the domestic aspect, it is more necessary for Chinese policymakers to maintain internal and external balance, as well as to keep the interest and exchange rates relatively stable.
Final analysis conclusion:
The continuous depreciation of the RMB exchange rate not only reflects the weakening of the Chinese economy but is also the result of maintaining the independence of its monetary policy. As the external balance becomes increasingly fragile, taking into account both internal and external factors will be the main task of China's monetary policy this year.
