Appreciating the Yuan's Depreciation
  ·  2016-01-14  ·   Source: NO. 3 JANUARY 21, 2016

With regard to the recent dramatic devaluation of the yuan against the U.S. dollar, Xu Hongcai, Director of the Economic Research Department at the China Center for International Economic Exchanges, shared his views in an exclusive interview with Beijing Review  reporter Deng Yaqing. Here are edited excerpts from the interview:

Beijing Review : What do you think are the major causes behind the recent depreciation of the yuan?


Xu Hongcai: In my view, it's a result of irrational psychological anticipation incited by some overseas speculators who want to reap profits from it. For one thing, China's economic fundamentals remain sound; for another, the country is still attractive to long-term international capital, as its foreign direct investment (FDI) ranks No. 1 globally. Therefore, expectations of a drastic depreciation of the yuan are groundless.

While the foreign exchange market may be negatively affected by short-term flows of funds such as the swap of hot money, the exchange rate formation mechanism is determined by long-term funds, which keep flooding into China, tapping into investment opportunities. Given that, the authorities should strengthen their supervision over the transfer of short-term funds.

In short, the strengthening of the dollar after the U.S. Federal Reserve's interest rate hike has resulted in the yuan's depreciation. The reason lies in the United States, rather than in China.

If the yuan continues to depreciate this year, what impact will that have on the Chinese and global economies?

There would be both positive and negative influences on China's economy. The yuan's exchange rate is not just determined by the dollar, but also by a basket of currencies including the euro and the Japanese yen. The effective exchange rate of the yuan is still on the rise. By and large, the yuan is now appreciating against all other currencies except for the dollar, and it had actually strengthened by 3 percent in 2015. How can the yuan maintain a trend of moderate increase in value? It's because the world is confident in China's economic fundamentals. In essence, the yuan is still a strong currency.

In the past two years, the yuan's exchange rate against the dollar was stable, which contributed many benefits to the world economy. Since the combined GDP of China and the United States makes up one third of the world's total, the stability of the yuan's exchange rate against the dollar is of eminent importance. China has pledged not to deliberately precipitate currency devaluations or start a currency war.

Admittedly, the yuan's depreciation against the dollar is conducive to China's export trade with the United States, which is also bolstered by the recovery of the U.S. economy. Additionally, the yuan's depreciation against the dollar can alleviate the pressures it has accumulated from appreciation against the euro and the yen. Moreover, China's exports to the European Union, Japan and the Association of Southeast Asian Nations (ASEAN) have fallen remarkably, which also undermines China's economic growth. As a major engine for global growth, the decline of China's economy will produce a negative influence on the world economy.

In the context of the market's equilibrium, slight fluctuations in the yuan's exchange rate are normal. However, no one would benefit should the yuan depreciate too much.

What's your prediction on the trend of the yuan's exchange rate this year?

Recently, the yuan's depreciation against the dollar has been too drastic, which was beyond my expectation. I hope this year the yuan can depreciate by 3-5 percent against the dollar and its effective exchange rate can appreciate by 2-3 percent against other currencies in order to ensure the stability of the foreign exchange market.

Since China's economy is fundamentally sound, it should be no problem for the country to realize 6.8-percent growth this year, which would be an amazing achievement in the eyes of the rest of the world. In contrast, the United States would be applauded if it could register a growth of 3 percent. Given that, drastic depreciation is unlikely.

What China's policymakers should do now is to strengthen market confidence through reasonable policy guidance and properly control the outflow of hot money. To stymie the flow of hot money, authorities should do more to intervene in both onshore and offshore markets.

The yuan started depreciating immediately after being included into the IMF's Special Drawing Rights (SDR) basket. Is there a correlation? What challenges do you think the currency will encounter in the future?

The direct impact brought about by the yuan's SDR inclusion is limited. Though it has been expanded, the size of the SDR is merely $285 billion or so. It's just a means of accounting for the IMF and isn't circulated in the international market. Joining in the SDR means an escalation of the yuan's credit rating and a greater role for the yuan in the global market. In the future, the People's Bank of China should pay close attention to both domestic and overseas yuan markets and keep a close eye on both the yuan's interest and exchange rates. Therefore, the central bank will have more jobs to do in the future, such as properly guiding market expectations and effectively communicating with the market, in order to prevent rampant speculation and ensure the stability of the yuan.

Copyedited by Bryan Michael Galvan

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