Rise of the RMB

Redback in focus

The yuan slumped versus the dollar in April


Foreigners have been sellers

The yuan slid more than 4% against the dollar in the offshore currency markets in April, setting it on course for its worst month for more than a decade.

The slump is effectively a reversal of the situation in late 2020, when the US economy was suffering from pandemic-related disruption while China’s economy was coming out of the worst of Covid-19.

A series of Chinese trade surpluses then saw the renminbi reach its strongest levels on record against a basket of trading-partner currencies. Stronger performance from the economy also fed through into more interest in the renminbi, as foreign investors bought up Chinese equities and bonds.

Of course, in more recent months the US economy has recovered from the worst of Covid. Inflationary pressures are now the greater concern and investors are taking the view that the Federal Reserve is likely to hike interest rates for the foreseeable future, making the dollar a more attractive choice than the yuan.

At the same time, the Chinese economy has been slowing, reducing overseas demand for its currency.

In previous periods of slowing growth China’s authorities have sometimes guided the yuan to a weaker position against the dollar in a bid to give exports a boost. But the consensus from commentators is that Beijing hasn’t taken a decision to drive down the yuan in this way over the last few weeks. If anything, the Chinese government wants to slow the pace of the yuan’s decline. Hence the central bank announced last week that it was reducing the reserve ratio requirements for the amounts of foreign currency that banks need to hold – a move designed to alleviate some of the weakening pressure on the yuan.

China’s currency seems to be coming under more pressure from investors, however, who have lost confidence in the Chinese economy and started to sell down yuan-denominated assets.

More of that selling pressure is now coming from foreign investors too, with overseas investment in the Chinese markets rising beyond Rmb8 trillion yuan ($1.2 trillion) at the end of last year, compared with about Rmb1.5 trillion in 2015, according to the central bank.

Also importantly, the People’s Bank of China seems less inclined to restrict capital flows out of China, another break with the past in which it has tried to stem periods of rapid depreciation of the renminbi by blocking investors from moving assets offshore.

“Although the RMB’s decline has been quick, this should not be interpreted as a FX policy stance introduced by design. The reasons are fundamental in nature and not introduced to ‘reflate’ the economy as some suggest,” Paul Mackel, global head of FX research at HSBC, argued in a research piece last week. “If anything, the flexibility in the exchange rate shows how it has become more sensitive to portfolio flows, as we put forward previously when foreign investors were first allocating investments to China’s market.”

Foreigners reducing their bond and equity positions in China accounted for outflows of $23 billion and $28 billion in February and March respectively, he added.

The trend also seems set to continue, following the release of new economic data for April last weekend. Much of it looked ominous, with manufacturing and services activity plunging to its lowest levels since February 2020 (when the first wave of lockdowns were introduced to counter the initial outbreak of the virus in Wuhan).

Only a day earlier the Politburo, led by Xi Jinping, the Chinese president, had promised to deliver on the country’s growth target of “around 5.5%” for the full year. But most economists wonder how that is going to be achieved while the government is also pursuing a ‘dynamic zero-Covid’ policy, with a series of urban lockdowns wreaking wider damage across the economy. 

GDP dropped 7.9% in the first quarter in Jilin province, one of the earliest areas to go into a fuller lockdown in March, for instance. But much bigger economies have suffered from similar constraints since then, including Shanghai’s. The fear is that the economic impact of China’s push for ‘zero-Covid’ could turn out to be even worse for much of the second quarter. 

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