Date
12 December 2017
The government's efforts to crack down on speculation have been undermined by businesses taking advantage of the interest rate gap between loans in yuan and the greenback. Photo: Reuters
The government's efforts to crack down on speculation have been undermined by businesses taking advantage of the interest rate gap between loans in yuan and the greenback. Photo: Reuters

Down but not out — a little more upside left in yuan

The ongoing cycle of yuan depreciation seems to be long and deep. The currency has fallen by more than 3 percent against the US dollar this year, reversing the appreciation that came after the end of the currency peg amid the global financial crisis in 2010.

The yuan’s effective exchange rate index as measured against a basket of currencies is at its lowest level since March 2013, according to the Bank for International Settlements. But analysis of economic data and the motives of policymakers suggests that the yuan has the potential to appreciate in the near term, but an end to the uptrend may come in the medium term, possibly in a year or two.

China continued to register a “dual surplus” in the first quarter. Its current account surplus amounted to US$7.2 billion and capital account surplus hit US$118.3 billion, suggesting that capital continued to flow into the country. This shows the market is still thirsty for yuan, providing a foundation for the currency to rise in value.

In addition, the central bank has continued to buy US dollars to release yuan in the past few months, as can be seen in the positive foreign exchange purchases. This also showed an obvious demand for the yuan.

This round of depreciation was more a result of the government’s efforts to crack down on speculative funds. Since taking office in March last year, the new central government administration has been committed to cutting the level of leverage in the economy to ease problems such as the overreliance on the property market, mounting debt levels and slow progress in economic restructuring. It has stuck to a tightened monetary policy even as the economy has slowed at times — all in the hope of curbing excessive and easy credit.

But the government’s good intentions have been undermined by businesses taking advantage of the interest rate gap between loans in yuan and the greenback. A typical way of getting easy and cheap loans is to use an overseas-registered subsidiary to borrow in US dollars and then transmit the money to the parent company in China through fake trade. The money is then invested by the parent company in China. Because the yuan’s interest rate is much higher than the US dollar’s, the company can benefit from cheap loans from overseas and high returns in China. This explains why China’s trade figures are often distorted.

This practise emerged in 2009 when China expanded cross-border yuan settlement and has become rampant in the past two years, prompting greater government vigilance.

That is why top policymakers have tried to narrow the rate gap by depreciating the yuan. They want a falling yuan to squeeze speculative funds out of China and deliver a warning to the market that the yuan is not always a one-way street.

Their efforts have paid off. China’s trade figures slowed sharply on yearly terms, showing that speculative funds were driven out, lending authenticity to the data.

The yuan’s depreciation also came as the Chinese economy slowed in the first quarter. Global investors are adopting a wait-and-see attitude toward China, with foreign direct investment slowing sharply, putting some downward pressure on the yuan. After all, the value of a currency is ultimately based on its economy’s strength and effectiveness.

But with the Chinese economy expected to improve in the second quarter, this pressure will diminish.
So, the yuan still has the chance to register some growth for the whole of 2014, so long as there is still a capital surplus.

But the room for the yuan to rise will shrink in coming years; it’s very close to the equilibrium point.

China’s current account surplus has been smaller than 3 percent of GDP for three years in a row. A rate lower than 4 percent is often considered equilibrium for the currency’s exchange rate. On the international front, accusations of an “undervalued yuan” have almost disappeared in the past few years, suggesting that other countries also believe the yuan’s value is now quite fair. The recent US criticism over a depreciating yuan was more about a sudden turnabout in policy instead of the pace of the drop in value of the yuan.

According to the Peterson Institute for International Economics, the yuan is already fairly valued. The institute’s research used the 2011 purchasing power parity estimates of GDP released by the World Bank on April 30 and projected the yuan’s equilibrium valuation for 2014, concluding that the currency is not undervalued at all.

The writer is a commentator based in Beijing and has been a journalist for more than 10 years on the mainland and in Hong Kong. He writes mostly on China’s economic issues.

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SK

The writer is an economic commentator. He writes mostly on business issues in Greater China.

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