The Chinese yuan’s value has been on an unprecedented rise over the past few months. Amid the decline in the US dollar, the offshore yuan reached below 6.4 per dollar by the end of May, its strongest level since 2018. This rise in Yuan was led by a surge in Chinese stock price due to increased foreign purchases.
The influx of foreign investment into the country’s relatively high-yielding markets has played one role in the yuan’s strengthening. Investment bank Natixis reported that the foreign share of mainland China’s bond market has increased from 3.2% in December 2020 to 3.44% in April 2021, with foreign investors purchasing $9 bn worth of mainland Chinese bonds during the month.
The growth of the Chinese yuan is further attributed to China’s rapid recovery from the Covid-19 pandemic. Economic indicators in the country have recovered faster compared to other emerging markets and most developed economies. According to the International Monetary Fund, the government’s macroeconomic and fiscal policies have fuelled China’s economic recovery.
The constant rise in the Chinese yuan value has, however, triggered several concerns for the export-oriented economy. This has prompted China to initiate several measures, that will hamper the yuan’s further growth.
Why hamper the growth in Chinese yuan value?
China’s government has been adamant about slowing down the recent surge in yuan value against the US dollar. This is because a stronger yuan would mean lower costs for commodities and other raw materials denominated in US dollars.
Higher Chinese yuan value would also make export products less competitive, affecting the country’s ongoing recovery from the pandemic. The export growth this year is one factor experts are contributing to the country’s quick recovery. The sector has been a major employment source amidst the economic fallout from the Covid-19 pandemic.
Data from China’s National Bureau of Statistics showed that the sub-index for new export orders has fallen below 50 for May. This indicates that the recent surge in the Chinese yuan value has affected overseas demand.
The influx of foreign investments appears to be a positive effect of the yuan’s strength. However, China’s financial stability has become a concern. Local asset bubbles and inflation may arise from an excess flow of unwanted money into China.
Sheng Songcheng, former director of the surveys and statistics department at People’s Bank of China (PBOC), said in an interview with state-run Xinhua News Agency that a large influx of speculative money into China should be prevented. He argued that this may negatively affect the country’s financial market and independent monetary policy.
“We will prevent short-term money flooding from pushing up the yuan and diminishing the competitiveness of export firms,” Sheng said.
The former PBOC official explained that the surge in the Chinese yuan value would cause a decline in export companies’ margins, particularly for small and medium enterprises (SMEs). He added that the yuan’s appreciation could damage the broader economy if firms focus on speculation instead of their primary business.
Slowing down the yuan’s rise
The PBOC announced an increase in the foreign exchange reserve requirement for banks last week as part of the government’s initiative to cool down the yuan’s rise. Beginning June 15, 2021, banks will need to hold 7% of their foreign exchange in reserve.
The PBOC directive represents a 2% increase in the requirement. It is the first hike since 2007. This move could affect the Chinese yuan, demonstrating the central bank’s position on the currency’s recent surge.
As per PBOC, the measure will help with liquidity management and effectively lower the US dollar supply and other currencies onshore. This will pressure the Chinese yuan to weaken. On June 1, the central bank set its daily reference rate at 6.3572 yuan per US dollar. This was after the currency went up by 0.2% to 6.3634 per dollar in Hong Kong and by 0.1% onshore.
The announcement appears to have achieved its objective of impeding the Chinese yuan value from growing further against the US dollar. The exchange rate stood at 6.40 yuan per US dollar recently (June 3-8, 2021), after 6.36 on May 31.