According to analysts, the yuan’s strengthening can be associated with China’s stabilised economy and the country’s successful management of the coronavirus pandemic, compared to a number of Western countries, including the United States.
If previously Chinese authorities tried to prevent the yuan from so rapid strengthening, the situation may change now.
The yuan is not a freely convertible currency. The so-called yuan reference rate is set daily by China’s Central Bank. The real exchange rate can deviate from it by no more than 2%. The People’s Bank of China has always had enough tools to control the yuan exchange rate.
The yuan was not allowed to strengthen too much, as the People’s Bank of China carried out foreign exchange interventions so that exporters didn’t end up facing difficulties; nor was it allowed to fall too much.
For example, during trade tensions between China and the United States, for quite a long time, the yuan exchange rate was about 7 yuan per dollar without crossing a psychological barrier. However, Chinese authorities eventually decided to take care of foreign exchange reserves and lowered the yuan rate.
Paradoxically, the US started accusing China of understating the yuan, although it was falling due to negative market trends.
The current situation is reversed. China has noted that it is better than most countries in managing the coronavirus pandemic consequences. According to IMF forecasts, by the end of 2020, the Chinese economy will be the only nation to show growth.
August statistics give reason for optimism, according to reports from Beijing. In August, retail sales amounted to 3.36 trillion yuan, 0.5% more than the previous year. Exports of Chinese goods are reportedly growing as well. In August, exports grew by 13.7% year on year, twice as much as a month earlier.
As a result, the current account surplus amounted to $119.6 billion. In comparison, a year ago this figure was $30.52 billion. The current account surplus is also pushing the yuan upward, as the country has, according to reports, turned out to be less dependent on foreign currency.
The yuan exchange rate is influenced by fundamental economic indicators. Therefore, in the current context, the growing yuan exchange rate is natural, Xu Jiyuan from the Centre for International Finance Studies at the Institute of World Economy and Politics of Chinese Academy of Social Sciences said.
“The yuan is strengthening due to the dollar’s volatility and the relatively good performance of the Chinese economy. The yuan exchange rate fluctuates, and the yuan’s current upward trend in relation to the dollar is expected to continue for several years. However, a new model for the development of double circulation and mutual advancement with a focus on the domestic market is a medium and long-term development strategy that will be an important area of economic development for the 14th five-year plan. This is longer than China’s macroeconomic cycle or exchange rate cycle. Moreover, there are other factors affecting the yuan exchange rate in the medium and long term, such as population structure, national net savings, the balance of payments etc.”
The double circulation strategy announced by the Chinese authorities is a response to the current state of the international economy and trade. According to this strategy, the domestic market and consumption become the main drivers of Chinese GDP’s future growth.
At the same time, isolating the economy is out of the question. The outer loop, exports, should support the development of the inner loop. In the context when world demand is falling amid the crisis, and a number of states are pursuing the policies of unilateralism, trade and technological protectionism, reducing dependence on foreign markets seems quite logical.
If the focus is on stimulating domestic consumption, cheap imports will come in handy. Moreover, the threat of Western financial sanctions makes China consider reducing its dependence on international payments in dollars. According to Xu Jiyuan, the yuan’s strengthening has a beneficial effect on its internationalization.
“The yuan’s strengthening has both advantages and disadvantages, but its current appreciation mainly reflects the fundamentals of China’s economy and coincides with a general depreciation of the dollar. The Chinese authorities don’t interfere in managing the yuan exchange rate. The yuan is expected to remain stable in the coming years and even strengthen against the dollar. This will help promote cross-border use of the yuan, especially for foreign investors who will choose the yuan as an asset.”
While Western states are pursuing zero interest rate policies, the Chinese debt market is becoming increasingly attractive to investors. In July, foreign capital net inflows into Chinese bonds reached $21.3 billion, the highest since 2014, when the statistics started being published.
Given that the Chinese authorities, as well as investors, are interested in raising capital and increasing the openness of their financial markets, it’s likely that a much larger part of global assets will be denominated in yuan in the future.