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As Yuan Nears 15-year Low, China’s Hands Tied on Monetary Stimulus

The yuan is hovering within striking distance of a 15-year-plus low against the dollar as U.S. interest rates settle firmly above their Chinese equivalents, limiting Beijing’s options for reenergizing a sluggish economy.

The Chinese currency ended the trading day in Shanghai on Wednesday at 7.244 against the dollar. The yuan had softened to 7.273 last Friday — its lowest point since last November — two days after the People’s Bank of China’s monetary policy committee held a quarterly meeting at which it said it would “fend off the risk of drastic ups and downs in exchange rates.”

If the yuan falls below last November’s nadir of 7.328, that would be its weakest level since December 2007.

The recent selling has been driven mainly by what the PBOC referred to as the influence of monetary tightening in advanced economies. Repeated hikes by the Federal Reserve pushed U.S. long-term interest rates above China’s last year for the first time in about 12 years.

The projections released by the Fed in June suggest two more increases in 2023, which would lift long-term rates to nearly 4%. China’s benchmark 10-year government bond yield, meanwhile, is sitting in the 2.7% range, close to an all-time low. This apparent new normal of higher yields in the U.S. than in China has dented the latter’s ability to attract capital.

The yuan’s slide is alarming the Chinese government, which still has fresh memories of the “yuan shock” of 2015, when it nearly lost its grip on the exchange rate.

The PBOC is taking action to check the currency’s decline. Reuters has reported that the central bank has guided lenders to cut interest rates on dollar deposits.

The Bank of China, one of the four big state-owned institutions, is offering a 0.5% annual rate on six-month time deposits for retail customers — down from 2.6% in early June and below the 1.7% rate on yuan deposits — removing an incentive for depositors to sell yuan for other currencies.

China’s currency troubles come at a challenging time, against the backdrop of a slow economic recovery.

The official manufacturing purchasing managers’ index came in below the boom-or-bust mark of 50 for a third straight month in June. Even after the end of the government’s zero-COVID policy, many still harbor deep-rooted worries about their jobs and income, and the property market’s persistent weakness is contributing to disinflationary pressure.

But the PBOC remains leery of making any substantial rate cuts to boost the economy, out of concern about widening the rate differential with the U.S. and potentially accelerating the yuan’s slide.

When the currency softened last fall, China added a “countercyclical factor” back into calculations of the yuan’s daily fix against the dollar to check its decline. The central bank also lowered the foreign exchange reserve requirement ratio, or the amount of foreign currency that commercial banks need to keep set aside.

An analysis based on Huachuang Securities’ currency model shows signs that the PBOC is adjusting its countercyclical variable. Since the Chinese government is reluctant to engage in direct intervention that would draw down its foreign exchange reserves, such indirect measures are expected to be its main tools for countering the downward pressure on the yuan.

Source: Nikkei Asia