In recent times, the economic landscape of China has been witnessing a significant shift, especially concerning its currency. The yuan has recently undergone a noticeable decrease in value, moving from a position of 6.7 Yuan per dollar in January to a concerning 7.3 Yuan per dollar recently.
This transformation is not merely a random fluctuation. Rather, it reflects several underlying economic challenges and monumental events (such as the recent real estate crisis) that have been instrumental in affecting investor confidence. Furthermore, these challenges have altered the very dynamics of how the yuan is traded, thereby leading to its devaluation.
To delve deeper, there are three primary reasons for this observed decline:
- Capital Outflow: The past few months have seen China grappling with an unprecedented capital outflow. To quantify, a $49 billion exited from the capital account just in the previous month. This is the largest capital outflow since December 2015. Such vast outflows have inevitably exerted downward pressure on the yuan. As the demand for the currency took a nosedive, its value followed suit.
- PBOC’s Intervention (tight-grip policies): The People’s Bank of China (PBOC), not being a mere spectator to this changing scenario, has been proactive. Trading volumes have seen a drop, from 30 billion per day in the previous year to a mere 12 billion recently. This is no accident. The PBOC aims to counteract the yuan’s weakening trend. By narrowing the fixing range of the exchange rate and allowing the spot rate to catch up, it is making a concerted effort to provide a semblance of stability to the currency. Furthermore, they have imposed several restrictions on capital outflow. By doing so, the bank ensures that large sums of money cannot quickly exit or enter the country. This strategy offers a protective layer to the yuan, shielding it from sudden, drastic fluctuations.
- Impact of the Golden Week: The Golden Week holiday, a national holiday from Oct 1 to Oct 8, further adds a layer of unpredictability to the yuan’s performance. This eight-day hiatus means there will be no daily reference rates due to the onshore market’s inactivity. In the absence of these daily fixings, the offshore yuan becomes a playground for increased intraday volatility. This makes it even more susceptible to sharp market swings.
Taking a broader view, these developments have far-reaching implications for China’s economic future. The considerable capital outflows are a glaring sign of declining investor confidence. If such a trend persists, China might find itself caught in a vicious cycle that has the potential to severely impact not just the financial markets but the broader contours of its economy. Given the current divergence in monetary policies and the overarching macro environment, China faces an uphill task. Attracting capital back into its economy, especially in the near term, presents a daunting challenge, thereby casting a shadow over its economic prospects. If the PBOC continues to employ tight-grip policies (constraining the exchange rate), it might provide a temporary shield to Yuan. However, as long as people are passive toward China’s economy, PBOC won’t attract capital, and thus, the yuan will continue to depreciate.
