Expect a stronger yuan against the dollar as Chinese economy grows stable

The Chinese yuan traded at 6.8648 to a US dollar in intraday trading in the offshore market on Jan 5, up 900 basis points compared with its lowest mark set the previous day, which was its biggest one-day gain in almost a year.

A Bloomberg report on Dec 28 saying that onshore yuan had dropped below the key 7 defensive line against the dollar, which China’s central bank immediately condemned as “irresponsible” media reporting, continued to trigger concerns over a latent acceleration in the yuan’s depreciation even in the first week of January.

The real changes in the exchange rate market, however, were about a stronger US dollar, not a weaker yuan. This is not a word game. The recent depreciation of the yuan is a reasonable response to a stronger dollar after Donald Trump won the presidential election in the US and the possibility of the Federal Reserve raising interest rates.

As of now, there is no fresh reason for the yuan’s persistent depreciation, as China’s economic growth is entering the new normal and becoming stable following improvements in some important indicators, such as the producer price index, which has bottomed out and entered the positive territory.

Governments at all levels have also achieved progress in reducing overcapacity and cooling down the overheated property market. The guideline on better protection of property rights, which was issued in November, is expected to curb the sharp decline in private-sector investment. Should this year’s growth pick up even slightly, persistent devaluation of the yuan would be more unlikely.

But other external factors may add to the yuan’s devaluation pressure. Many major currencies, including the British pound and euro, have witnessed bigger depreciation in the face of a robust dollar, partly thanks to the United Kingdom’s exit from the European Union. A yuan insusceptible to these changes is not in the interest of Beijing’s trade and investment exchanges with London and Brussels.

That said, investors are supposed to keep a close eye on whether a bigger decline is possible in the values of the pound and euro instead of the yuan. Currencies of emerging economies, especially leading bulk commodity exporters, are not likely to keep depreciating against the dollar either, as Trump seems poised to double the spending on US infrastructure.

The yuan-dollar exchange rate, in the long run, is essentially about the two countries’ economic growth and inflation. One can safely say China’s economy will grow nearly twice as fast as the US’ in the coming years and its inflation is unlikely to be higher than the latter’s. And since the national debt of the US could soar if Trump honors his spending promise, it will make the yuan stronger against dollar in the future.