WASHINGTON — A stronger U.S. dollar will likely lead to a gradual depreciation in the yuan over the next 12 months as China strives to limit economic volatility.
That’s the view of some economists and foreign-exchange strategists. They say the dollar will strengthen against the euro, sterling and the yen as a growing American economy outperforms troubled Europe and Japan.
China’s renminbi — the yuan’s other name and literally “the people’s currency” — will depreciate gradually against the dollar along with those other major currencies. China’s ambition for its redback to become a major global payment tool will also lose traction, some experts say.
“It’s more about the dollar strengthening than the renminbi weakening,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman. The People’s Bank of China “will tolerate market forces, because market forces are moving in their desired direction.”
Chandler, in a phone interview, said his firm estimated the dollar-yuan exchange rate will rise to 6.84 in a year. The rate stood at 6.6364 as of 11 p.m. Wednesday in Shanghai, according to the China Foreign Exchange Trade System, an arm of the Chinese central bank that facilitates interbank trading.
One year after the yuan’s biggest one-day drop in more than two decades roiled global markets, China has fended off bears betting against its currency, stemmed capital outflows, and eased investors’ concerns of sharp depreciation.
Experts said economic stability is China’s primary goal going into the G-20 Summit in Hangzhou next month, the U.S. election in November, and China’s own leadership transition in 2017.
Dollar strength
The yuan will be on a gradual downward trend tracking a basket of trade-weighted currencies as the dollar appreciates against everything else, said Desmond Lachman, an economist at the American Enterprise Institute. Lachman testified at a Senate banking committee hearing on China’s financial risks last month.
“In the next 12 months, we are going to see a lot of dollar strength, because the U.S. economy will be doing a lot better than the Japanese and European economies,” Lachman said.
The CFETS RMB Index, a measure of the yuan’s performance against a basket of 13 currencies, has dropped more than 6% to 94.72 since the beginning of this year. And the yuan has weakened about 2.2% against the dollar. The dollar index has slipped 2.9%.
The PBOC, the central bank, said the yuan’s 1.9% one-day drop on Aug. 11, 2015, was a one-off adjustment, and that the new mechanism for setting the yuan reference rate factored in more market-based considerations.
After the surprise rate move last August, Chinese central bank Deputy Gov. Yi Gang said the bank set the daily dollar-yuan central-parity rate by averaging rates submitted by between 10 and 20 market makers after eliminating the highest and lowest rates.
Those market makers — commercial banks that sell or buy currencies and profit from price differences — had to consider the previous day’s closing spot rate and foreign-exchange supply and demand. They also looked at changes in major currencies.
In a report last week, the PBOC reiterated that it would keep the yuan exchange-rate relatively stable based on supply and demand. It said it would also consider the performance of a basket of currencies for reference.
Prevailing upside
Ian Gordon, foreign-exchange strategist at Bank of America Corp. in New York, said increased global competitiveness of Chinese exports will trump the downside of increasing import costs for consumers and Chinese companies as a result of the gradual yuan depreciation.
In July, China’s exports and imports fell more than expected, stoking concerns about the outlook of demand in China and abroad.
“The PBOC needs to use the exchange rate to support growth as they hesitate to use lower lending rates given the excess debt levels,” Gordon said in a phone interview.
“They will also continue to have a bias for a weaker currency,” he added, “which means in a weaker dollar environment, they respond more strongly to prevent more renminbi appreciation, and in a stronger dollar environment, they allow that to let the renminbi weaken.”
Gordon also said investors will see value in Chinese assets at some level of the exchange rate with the gradual weakening of the yuan.
A 27-month capital outflow streak slowed its pace to about $64 billion in the second quarter this year from a record $226 billion in the third quarter last year, according to the Institute of International Finance, a group tracking global investment flows.
China’s foreign-exchange reserves were little changed last month, after the central bank in Beijing burned through $3.56 trillion since August 2015, mainly to defend its currency.
Low profile
China doesn’t want its currency to draw fire when leaders from the G-20 economies convene next month in Hangzhou, China, said David Dollar, a senior fellow at Brookings Institution and the Treasury Department’s former emissary to China. It also doesn’t fancy adding fuel to any trade backlash from the U.S. as it approaches the November presidential election.
Political change is also coming in China. The Chinese Communist Party will select some new leaders when it holds its 19th Party Congress around October next year. Leaders want to make the transition without economic and financial turmoil, which in turn could put a damper on the twice-in-a-decade change.
“If Xi Jinping and other leaders pick a slate of new leaders without much apparent infighting between different elite factions, that will give markets a good signal the leadership has a commitment to reform and is not going to be swayed by factional politics,” said Scott Kennedy, deputy director at Center for Strategic and International Studies, a Washington think tank.
Hampered internationalization
It’s clear that the PBOC’s market intervention and China’s economic slowdown have hamstrung the expansion of the yuan’s global use. The yuan’s share of global payments accounted for 1.72% in June, the lowest level since October 2014, according to the Society for Worldwide Interbank Financial Telecommunication.
Some economists said the decision to include the yuan in the Special Drawing Right basket, effective Oct. 1, was political. The SDR, an international reserve asset created by the International Monetary Fund, is a supplement to a country’s gold and currency reserves.
In a statement on its website today, the PBOC said it plans to further the yuan’s global use by improving infrastructure, expanding cross-border financing under the current account, and widening investment channels.
“The internationalization of the renminbi has been grossly exaggerated,” Chandler of Brown Brothers Harriman said. “The renminbi is not in a convincing uptrend the way it (once) was.”
Photo at top: One year after China’s yuan roiled global markets, analysts see it depreticating slowly as the dollar rises. (Harvard Zhang/Medill News Service)
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