Why China is reining in the renminbi
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On Monday, China’s central bank yanked a policy lever it hasn’t touched since the global financial crisis, signaling Beijing’s determination to rein in a currency rally that has seen the renminbi surge to its strongest level against the dollar in three years.
The People’s Bank of China decreed that starting June 15 the nation’s financial institutions must hold 7% of their foreign exchange in reserve. That’s an increase from the current reserve rate of 5%. It was China’s biggest-ever reserve rate hike and its first since 2007.
The move was mostly symbolic. The measure will make it slightly more expensive for China’s financial institutions to hold foreign currencies. Becky Liu, China macro strategist for Standard Chartered, per the Financial Times, estimates the move will suck about $20 billion worth of liquidity out of China’s foreign exchange market.
Even so, the order sent a clear message to banks and currency traders that further appreciation of the renminbi won’t be, well, appreciated. As CommerzBank AG economist Zhou Hao noted to Bloomberg, China’s central bank has all manner of additional weapons to combat a renminbi rally and is serving notice to speculators that if they try to push the currency much higher, “the market will fail.”
That would be putting an end to what, for the last year, has been a very profitable bet. In the last twelve months, the renminbi, also known as the yuan, has gained 12% versus the dollar. At the end of the day Tuesday, the Chinese currency was trading at around 6.37 to the dollar, its strongest level since May 2018. Against a reference basket of currencies of China’s trading partners, the renminbi is its strongest since April 2016.
The reasons for the renminbi’s surge against the greenback are straightforward. China bounced back from the shock of the COVID-19 pandemic more rapidly than any other major global economy. In the first quarter of 2021, Chinese GDP grew by a staggering 18.3% over the same period the previous year and is expected expand by 8% or better for the full year. The renminbi’s rally also has been driven by global investors’ enduring enthusiasm for pumping money into China—pandemic and escalating political tensions between Beijing and Washington notwithstanding.
But Beijing’s willingness to tolerate a stronger yuan has been harder to parse. A strong yuan puts pressure on Chinese exporters. For years, a favorite refrain of American China hawks from both political parties was that Beijing kept the renminbi artificially weak to create an unfair advantage for Chinese exporters. In 2019, the Trump administration branded China a “currency manipulator” after the reminbi weakened below the level of 7 to the dollar.
But over the past year, as the renminbi gained and the dollar weakened, the currency manipulator label has come to seem increasingly absurd. Among analysts and economists, the debate shifted to whether China’s leaders have learned to live with a stronger currency—and might even be contemplating allowing the yuan to trade freely.
One argument offered to explain China’s new currency confidence: the stronger yuan matches President Xi Jinping’s push to rebalance China’s economy by stoking domestic consumption and lessening the nation’s dependence on exports. (And, in any case, Chinese exports have boomed this past year despite the renminbi’s rise.)
Some noted that a strong currency makes it cheaper for China to import commodities and chips. Others speculated that perhaps China’s policy makers had refrained from intervening in currency markets because they feared positive economic conditions underlying the renminbi’s run-up are only temporary. Many suggested that the yuan’s rise provided the perfect opportunity for China to transform it into a global reserve currency to rival the dollar.
There are signs of debate within the PBOC itself. At an April 16 financial forum, Zhou Chengjun, head of the PBOC’s Finance Research Institute, argued that if the yuan is to become a global currency, it must be allowed to trade freely. “We need to admit that under the condition of yuan internationalization, we won’t be able to control the exchange rate, and China’s central bank has to let go of exchange-rate goals in the end,” Zhou said, according to a transcript.
In an April 18 speech to the China’s Boao Forum for Asia, PBOC deputy governor Li Bo seemed to reject the notion that China intends the renminbi to become a global reserve currency. “Our goal is not to replace the U.S. dollar or any other international currency, our goal is to allow the market to choose and to facilitate international trade and investment.”
And on Sunday, another deputy governor, Liu Guoqiang, dismissed market speculation about liberalizing the yuan. In a brief statement on the PBOC’s website, Liu declared that China’s existing managed floating exchange rate system is “an institutional arrangement fit for China at present and the foreseeable future.”
For now, the idea of completely liberalizing their currency is one to which China’s leaders remain unconverted.
More Eastworld news below.
This edition of Eastworld was curated and produced by Nicholas Gordon. Reach him at firstname.lastname@example.org.
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