No room for sharp drop in yuan
As a result of the rebound of the US Dollar Index, the yuan’s value has recorded a rapid depreciation against the dollar this year. Specifically, the central parity rate of the yuan against the dollar reached 6.95 on October 26, down by 10.8 percent from a rate of 6.27 on April 2.
While the yuan’s exchange rate has seen increased twoway volatility in recent years, its central parity rate against the US dollar has generally remained between 6 and 7.
China’s foreign exchange market is basically in equilibrium. In the first eight months of this year, the deficit of foreign exchange settlement and sales by banks totaled $10.5 billion. Considering other factors like spot transactions, forward transactions and options in the foreign exchange market, there has generally been a balance between supply and demand of foreign exchange in China.
The fluctuation of the yuan rate is supported by the country’s economic fundamentals. In recent years, China’s GDP growth has been relatively stable, with annual rates of 6.7 to 6.9 percent and quarterly fluctuations usually less than 0.1 percentage point.
In August, the surveyed unemployment rate in urban areas was 5 percent. Foreign direct investment (FDI) maintained a rapid rise due to opening-up policies, with FDI up 6.1 percent year-on-year in the first eight months of 2018.
With fundamentals supporting the yuan, plus the prudent management of the central government, the depreciation of the currency has remained controllable so far this year.
Given external uncertainties as well as other complex and unpredictable factors that may influence the foreign exchange market, any form of policy regulation and intervention should not be ruled out.
Since the marketization of the yuan rate has been greatly improved, policy intervention should also be combined with market factors to promote the general stability of the yuan’s exchange rate amid two-way fluctuation and increased volatility.
Broadly speaking, monetary and foreign exchange administration authorities can affect the yuan rate by adjusting supply and demand (in both offshore and onshore markets); changing the exchange rate formation mechanism; increasing or decreasing transaction costs; directly participating in transactions, and guiding expectations.
In terms of the foreign exchange formation mechanism, there is still room for adjustment to the counter-cyclical factor, the composition of the closing price and currency basket, and the fluctuation of the exchange rate.
The central authorities have avoided market intervention for quite some time, and they will not just participate directly in foreign exchange transactions in the future. If necessary, such as when the excessive fluctuation of the exchange rate causes market panic, it is reasonable to use foreign exchange reserves to intervene.
However, the use of foreign exchange reserves for market intervention will inevitably lead to a reduction in reserves, which in turn will be interpreted by the market as a weakened ability to intervene and raise concerns over further depreciation of the currency.
For this reason, it is usually not appropriate to use foreign exchange reserves to intervene in market transactions as stable foreign exchange reserves constitute the “ballast” for exchange rate stability.
When it comes to regulatory adjustment and intervention, it is important to make clear the goal of any action. If regulatory adjustment and intervention is meant to gain certain competitive advantages, such as devaluing a currency to expand exports, such intervention will often be unacceptable to the international community and may even cause discontent in relevant countries.
Nevertheless, if adjustment and intervention are made to stabilize the market so that the global economy can operate in a better environment, such interventions are totally justified.
The IMF has said that when the continuous and considerable fluctuation of a currency’s exchange rate generates a strong negative impact, its government can and should intervene.
A sharp fluctuation in a currency’s exchange rate, especially a major economy’s currency, will not only affect that country’s own economy, but will also be a disturbance to the international economy. Therefore, it is the responsibility of the authorities to ensure the smooth operation of the market.
Given growing external uncertainties, the ongoing trade war between China and the US, the different monetary policies of developed countries, the “herd effect” in the foreign exchange market, a relatively sharp fluctuation in the yuan rate, and a rise of irrational market sentiment, it is necessary for authorities to take measures to increase speculative transaction costs by adjusting the exchange rate formation mechanism as well as the market supply and demand relationship.
These measures will show that there is a bottom line to the tolerance for foreign exchange market volatility, acting as policy guidance to the market.
The US Treasury Department again declined to label China a currency manipulator in its latest report. The relevant data fail to support such an allegation.
The depreciation of the yuan, which has been at least 10 percent, has to a large extent reflected changes in economic fundamentals, pressure from the Fed’s rate hike and the impact of the trade war.
In this sense, there is no room for a sharp depreciation in the yuan in the near term. It is worth noting that the equilibrium exchange rate of the yuan is dynamic, and it is actually meaningless to emphasize any specific barrier.