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Special> Boao Forum for Asia 2015> Exclusive
UPDATED: February 2, 2015 NO. 6 FEBRUARY 5, 2015
Double-Edged Sword
The EU's quantitative easing could boost China's exports to the eurozone, but could also put pressure on the yuan
By Wang Jun

Since the PBC announced an interest rate cut on November 21, 2014, the yuan has depreciated rapidly. The PBC figures showed that in December 2014, the funds outstanding for foreign exchanges fell by 128.91 billion yuan ($21 billion) from the previous month, the biggest monthly fall since December 2003. Deng said the sharp fall of funds outstanding for foreign exchanges may be due to the PBC's intervention to alleviate the yuan's depreciation pressure.

"Judging from this, the Chinese central bank is reluctant to see the depreciation of the yuan," he said, adding that the yuan's depreciation may impede the process of developing the Shanghai free trade zone and making the yuan an international currency. It is not logical that China tries to spur exports by depreciating its currency.

A report on the Economic Information Daily said that the European QE could intensify the competitive depreciation of global currencies. The yuan will also face more depreciation pressure, but the depreciation won't be significant, and it may appreciate against other currencies.

Lu Zhengwei, chief economist of Industrial Bank Co. Ltd., holds different views. According to him, the effective exchange rate of the yuan is not at an equilibrium level now, and it has long been overrated. This is also the basic reason why the Chinese economy has not been able to recover as quickly as expected. If the overrating can be modified—through yuan's depreciation—China will easily resume economic growth above 7.5 percent. Lu has a bold estimation that the yuan will depreciate as much as 5 percent this year.

Impact on China

Since the scale of this round of QE is much bigger than expected, the euro is likely to continue depreciating in the short term, strengthening the U.S. dollar. As the yuan is unofficially pegged to the U.S. dollar, appreciation of the U.S. dollar will also push up the yuan's exchange rate against other currencies, imposing pressure on China's exports.

In the long term, however, economic recovery in the eurozone will increase China's exports. In 2014, the EU remained China's largest trading partner. Trade volume between China and the EU amounted to $615 billion in 2014, up 9.9 percent, according to data from the General Administration of Customs. Among the total, China's exports to the EU totaled $371 billion and its imports from the EU totaled $244 billion, up 9.4 percent and 10.7 percent, respectively.

"The program will help boost the eurozone's economy, increase demand and potentially boost China's exports, because Europe is one of China's most important trading partners," Pan said at the conference.

The European QE is likely to further boost investors' confidence and devalue the euro. Devaluation of the euro and decline of oil prices will intensify the pressure of imported deflation in China.

To address the possible risks of deflation and the pressure on economic growth, the PBC may further relax its monetary policy, predicted the Economic Information Daily report. It is expected that the Chinese Government will adopt relaxed or diversified monetary policy tools to ensure stable economic growth.

Meanwhile, the eurozone's QE will further undermine the euro's position as the world's second largest reserve currency. On the other hand, thanks to the yuan's stable exchange rate, China's high growth speed and large economic scale, its currency is expected to be accepted by more international investors.

The ECB's bond-buying plan will release a huge amount of liquidity, which will weaken the euro and force capitals to flow out and return to the United States. "The large liquidity brought forth by the new round of QE in the eurozone will no doubt cause a spillover effect, and the strengthening of the U.S. dollar's exchange rate will drive capital back to the United States. All this will increase the uncertainty of the international capital flow," said Pan. The Economic Information Daily report said that China may also receive some of these capitals.

When the yuan's use as a global currency increases, the euronzone's QE is likely to bring new opportunities for the internationalization of the yuan.

Email us at: wangjun@bjreview.com

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