By Zhang Bin | China Daily | Updated: 2022-10-24 09:28
Most currencies have recently depreciated against the US dollar given the latter's extremely strong performance this year. The renminbi has been no exception, and began to show depreciation signs in mid-April. The trend has been more noticeable since Aug 15, with the Chinese currency depreciating against the greenback by more than 5.9 percent in two months' time.
But based on past experience, the renminbi will not depreciate substantially given China's economic fundamentals. Additionally, moderate depreciation is conducive to economic stability.
It should first be noted that short — to midterm factors, instead of long-term reasons, have caused the renminbi's recent fluctuations. In other words, cyclical rather than structural factors have resulted in the Chinese currency's volatility. As long as China's economic growth stabilizes, the renminbi exchange rate will stand firm.
While China is a developing country, its forex fundamentals are nothing like that of most other developing economies. Drastic currency depreciation soaring to 30 to 50 percent, or even higher, which has been seen in some developing countries, will not happen in China.
Lessons from the past show that most dramatic depreciation periods take place in countries with high inflation or trade deficits.
According to significant depreciation cases recorded by the International Monetary Fund ever since the Bretton Woods system came to an end in the early 1970s, 148 out of the 157 cases — during which currencies depreciated by at least 15 percent in a single year — were concurrent with inflation or trade deficits.
Only nine depreciation cases happened when inflation was low or the nation reported a trade surplus.
These depreciation cases can be further attributed to five different reasons.
One is when economies face serious external crises, like the depreciation in South Korea between 2008 and 2009 and in Malta in 1993.
Second is when an extremely relaxed monetary environment causes depreciation, such as in Sweden in 2009 and in Japan in 2013.
Institutional monetary reforms make up the third major reason and caused deprecation in Denmark in 2000 and in Switzerland in 1997.
Fourth, over-evaluation of a country's currency resulted in depreciation in Japan in 1996 and in the Netherlands in 1997.
The fifth scenario involves excessive credit and foreign debts, which caused depreciation in Indonesia in 2001.
There are currently neither serious inflation conditions nor trade deficits in China. Nor can other reasons mentioned above be found in the country.
The renminbi exchange rate is supported by supply and demand dynamics in the forex market. For one thing, China manages to maintain $500 billion to $600 billion trade surplus every year. For another, lower inflation rates in China ensure the strong purchasing power of the renminbi in a real sense. The relatively stronger controls that China exerts over capital flows support the renminbi's valuation to some extent.
On top of that, the renminbi's exchange rate formation has been more elastic ever since China launched foreign exchange reforms in 2005, helping release any pressure in the domestic currency's supply and demand fundamentals. There is no depreciation pressure piled up from the past. Cross-border capital flows have remained stable and the renminbi is not experiencing the depreciation pressure that it underwent between 2015 and 2016.
The soaring US dollar index arising from continued interest rate hikes adopted by the US Federal Reserve is one major reason for the renminbi's recent depreciation. Major currencies such as the euro, Japanese yen and British pound have all depreciated significantly against the US dollar, and the renminbi is no exception. But the renminbi's trade-weighted exchange rate against all other major currencies, except the US dollar, has risen.
The relatively lower economic prosperity in China, especially the slowdown in exports, comprises another reason for the renminbi's recent downward performance. Past experience shows that the renminbi's exchange rate is closely related to short-term capital flows and domestic economic prosperity, whose elements are more influential than the US dollar index or the interest rate difference between China and the US.
Upon closer observation, the dominant players in China's foreign exchange market are not financial investors or individual households but companies specialized in foreign trade and investment. Companies' actions including foreign exchange settlement and sales, external borrowing or debt repayment, as well as purchases or sales of overseas assets are related to the number of orders they have received, companies' expectations of future cash flows and the extent of economic prosperity.
A rise in economic prosperity is often accompanied by net capital inflows and appreciation of the renminbi. But China's economic growth has been relatively slow of late, and export orders have also declined in the context of the ongoing global economic slowdown. All these have exerted a certain amount of pressure on the renminbi exchange rate.
But the rise of the US dollar index and slower economic growth at home are short-term phenomena. They are cyclical factors rather than long-term structural factors. The renminbi is expected to experience a period of weakness due to these factors, but it will not plummet.
China's monetary regulators have always stressed foreign exchange's role in stabilizing economic growth. Recent currency depreciation has helped stabilize China's macroeconomy in the sense of enhancing Chinese export attractiveness, elevating price competitiveness of various import substitutes and boosting demand.
Moderate depreciation is not troubling. On the contrary, it will play a positive role to some extent given the current economic situation.
What should be avoided is any large-scale renminbi depreciation. To prevent such a scenario from taking place, intervention in the foreign exchange market is not the optimal solution. Pressure latent in supply and demand dynamics in the forex market cannot be released in a timely fashion if intervention strengthens. Excessive intervention will only result in stronger market expectations of unidirectional depreciation and more downward pressure on the currency. Such intervention may also jeopardize the domestic money supply and macroeconomic stability. All these have been proven by history.
China's economic fundamentals are the very basic support of the renminbi. In the short run, countercyclical fiscal and monetary policies will help improve economic prosperity. In the long run, efforts should also be made to carry out more reforms to optimize China's economic structure.
The writer is a senior research fellow at the China Finance 40 Forum, a think tank, and a researcher at the Chinese Academy of Social Sciences' Institute of World Economics and Politics.
The views don't necessarily reflect those of China Daily.
