China should stay vigilant against currency crisis

刊于Global Times（环球时报.英文版），2018.6.29

Since the latter part of June, the yuan's devaluation has accelerated, with the yuan's daily fixing rate against the US dollar breaking above key levels - 6.45, 6.5 and 6.55. Other than dollar weakness, China-US trade rows have also contributed to the weakening of the yuan. The two countries reached a preliminary consensus on settling the trade disputes on May 20, but a few days later the US decided to slap tariffs on $50 billion of Chinese high-tech imports and even considered raising overall tariffs to $200 billion. 

This has resulted in turbulence in the international foreign exchange market and pushed for hedging demands. As a consequence, the value of the yuan has fallen substantially. Worth noting is that in trade terms the yuan's devaluation could to a certain extent boost Chinese products' international competitiveness, easing the pressure resulting from trade war-induced decline in external demand and serving as a boon for domestic exporters. 

Judging from China's economic fundamentals and policy leeway, there will be no room for the yuan to depreciate drastically and the country also has sufficient capacity to respond to external shocks. 

Since the second quarter of the year, the yuan has continued a depreciating spiral against the dollar. The yuan's daily fixing rate against the dollar has now weakened to about 6.6 from roughly 6.3 at the beginning of April, suggesting a decline of more than 3.5 percent. The yuan's weakness is mainly due to the dollar's staged strength plus escalated trade frictions. 

Looking ahead, however, the dollar will continue its trend stronger in the short term before heading for a trend reversal over the longer run. On the part of the yuan, there is a big possibility its weakness will continue while the currency gradually steadies. 

The dollar index has risen from below 90 all the way to above 95 since April, driven by the US economy's steady growth, the nation's inflation, which continues to edge up, and the sluggishness of the eurozone economic climate. The Federal Reserve recently announced a rate hike as expected and it hinted at a total of four rate hikes throughout the year. This, in addition to robust job and income numbers and inflation expectations, will see dollar strength persisting. The dollar index is expected to steady above 90 throughout the year.

But a strong dollar over the short term is not supposed to change the greenback's shift toward weakness over the medium to long term. The US economy has entered the late stage of economic recovery, and the dollar is already halfway through a strong cycle. This, compounded by market expectations for the European Central Bank to raise interest rates and the overall tightening of other major central banks' monetary policy, suggests the dollar's long-term weakness will not be essentially changed. The current round of dollar rebounds is likely to run its course within a few months, and after that the dollar will trend lower. The yuan, for its part, might weaken to a level of between 6.6 and 6.7 before seeing signs of stabilization at the end of the third quarter. 

It needs to be pointed out that the Chinese economy's deleveraging efforts are seen lowering social financing levels, resulting in debt defaults and also headaches for businesses to raise funds. Nevertheless, the economy's new growth dynamics, exemplified by new industries and business models, have picked up steam as the nation pushes for upgraded consumption and innovation-oriented growth in a sign of the economy's strong resilience. Apart from that, the country has sufficient forex reserves and it maintains a relatively independent monetary policy and has sufficient policy tools to deal with forex fluctuations. 

Still, the nation should stay vigilant against a possible currency crisis, factoring in geopolitical issues, competition between big countries and the internal deficiencies in the economic structure of some emerging markets, among others. 

It is advised that amid the China-US trade war and dollar strength, the country's forex regulator should hold to greater reform and opening-up while preventing risks associated with cross-border capital flows. The country needs to push ahead with market-oriented foreign exchange reforms, improving the yuan's exchange rate formation mechanism and increasing the yuan's exchange rate flexibility. Efforts are also required to increase the transparency of the country's forex policy and to continue expanding the yuan's two-way trading band based upon the forex market's demands and supplies. Market expectations would thus be effectively anchored, preventing estimations about a one-way rise or fall of the yuan. Also, the country should open up the financial market wider to the outside world in a prudent and orderly fashion, and gradually liberalize its capital account on the premise that risks are controllable, so as to lure overseas investors into the domestic capital market. 

附：合作作者，范炳龙，博士，江山控股高级研究员。

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