In recent times, the Chinese yuan or renminbi (RMB) exchange rate has undergone significant fluctuations. Since late June, the offshore RMB against the USD dropped below 7.2. Then, in early July, as the USD index declined, the RMB started to rebound and recovered to the 7.15 level on July 14, both onshore and offshore. Nevertheless, starting this week, after the release of Chinese economic data, the RMB has once again started to devalue, coinciding with the rebound of the USD index. By July 19, the RMB exchange rate fell back above 7.20. In the offshore market, which reflects international investors' expectations, the offshore RMB against the USD consecutively fell below 7.20, 7.21, and 7.22 on July 19th. This sharp fluctuation is influenced by external factors like the USD, as well as by the market's unstable expectations for the Chinese economy. In this situation, the short-term trend of the RMB exchange rate seems to have lost its direction.
On July 20, the People's Bank of China (PBoC) and the State Administration of Foreign Exchange (SAFE) announced an increase in the macro-prudential adjustment parameter for cross-border financing for enterprises and financial institutions from 1.25 to 1.5, which will be implemented on July 20, 2023. This policy indicates that China's financial regulatory authorities are intervening in the RMB foreign exchange market, leading to a substantial rebound in the Chinese currency’s exchange rate. On the morning of July 20, the onshore RMB approached 7.16 and reached a high of 7.1620, a significant rebound of over 600 points from the previous day's closing price. The offshore RMB against the USD also appreciated strongly, consecutively surpassing the 7.23, 7.22, 7.21, 7.20, and 7.19 levels, with an intraday gain of over 500 points. The market reaction shows that both the onshore and offshore markets are highly sensitive to the policy intervention by the PBoC and the SAFE. This also demonstrates that the Chinese central bank still possesses the absolute ability to influence the foreign exchange market prices under the circumstance of limited capital flow.
On the basis of the fluctuations in the RMB exchange rate last year, this year has seen another round of depreciation against the USD. The reasons for this recent depreciation, as highlighted in the China Banking Research Institute's 2023 Q3 Economic and Financial Outlook Report, can be attributed to three factors: first, the short-term rise in the USD index; second, the widening gap in interest rates between the U.S. and China; and third, the fragility of China's domestic economic recovery and weak external demand, which has affected the surplus in the current account and exchange balance. Both external and internal factors contribute to this situation. Researchers at ANBOUND have also emphasized that changes in China’s economic fundamentals are important factors affecting the fluctuation of the RMB exchange rate. Despite the slight recovery in the Chinese currency exchange rate in early July, the sharp decline in the recent period is primarily due to the lower-than-expected economic growth in the second quarter and the slowdown in export growth, indicating the close correlation between the country’s economic stability and exchange rate stability.
It is worth noting that despite the considerable volatility in the RMB exchange rate this year, the PBoC has not significantly intervened in the foreign exchange market, suggesting an increased tolerance for the currency’s fluctuations. The last time the macro-prudential adjustment parameter for cross-border financing was raised was during the previous round of RMB depreciation last year. However, recent adjustments to the currency's central parity rate have led many market institutions to believe that the PBoC has reintroduced counter-cyclical adjustment factors, indicating an inclination towards an independent direction of the central parity rate, detached from market changes. This signifies that the market price of the RMB exchange rate is approaching or surpassing the central bank’s tolerance threshold, prompting it to take action and intervene. Based on previous cycles, despite larger fluctuations in the offshore market, its limited scale keeps it within the PBoC's control, preventing it from spiraling out of control. Considering the more constrained onshore market, the PBoC still plays a decisive role in stabilizing the yuan exchange rate.
Recently, PBoC Governor Yi Gang also mentioned that interest rate policy and exchange rate policy are not parallel, with interest rates being the core while the exchange rate is formed by the market under the influence of interest rate policy. Yi pointed out that monetary policy regulation should prioritize domestic objectives and choose optimal policies such as interest rates to achieve domestic goals, as well as create a favorable environment for the exchange rate to be determined by the market. This also implies that the trajectory of the RMB exchange rate will not deviate from the equilibrium state for an extended period.
In the current situation, the central bank is cautious about intervening in the market. On one hand, it expects the market to self-regulate, while on the other hand, it is concerned about potential excessive capital outflows. Given the existence of a distorted exchange rate mechanism, cross-border capital flows are inevitable. Consequently, researchers at ANBOUND believe that the PBoC's adoption of a flexible exchange rate policy is aimed at ensuring stability in the domestic market and finding a balance between capital flows and exchange rate fluctuations. However, this strategy is contingent upon the stability of the Chinese economy and future expectations. Assuming the economy continues its steady recovery in the second half of the year, the short-term fluctuations in the RMB exchange rate are unlikely to greatly impact its long-term trend of returning to equilibrium.
Despite the significant current fluctuations in the RMB exchange rate amidst growing uncertainties, a broader, long-term view suggests that the currency is unlikely to experience substantial depreciation due to the influence of stable domestic monetary policies. Moreover, with the global economy slowing down and inflation persisting, the RMB is expected to maintain a long-term trend of appreciation. However, this outlook is contingent on China's economic recovery and the degree of RMB internationalization.
Final analysis conclusion:
In the short term, the RMB exchange rate has experienced increased fluctuations influenced by factors such as changes in the USD, China’s economic conditions, and policy shifts. These fluctuations remain within the purview of financial regulatory authorities. Nevertheless, the Chinese central bank cannot fully control the market and must still adjust according to economic principles. The foundation of exchange rate stability relies on the stability of the domestic economy. The short-term volatility of the exchange rate does not affect its long-term trend of returning to a reasonable equilibrium.
