ince mid-April, the exchange rate of the Chinese yuan against the US dollar has gradually declined from around 6.8 to a low of around 7.15, representing a depreciation of nearly 5 percent. This downward trend is driven by both external and domestic factors.
Externally, the US Federal Reserve has maintained a hawkish stance and has hiked interest rates multiple times since the beginning of the year. Compounding the rising US bond yields, this attracts global asset flows back to the US. As a result, the US Dollar Index has been on the rise in recent months.
Another reason is that China’s central bank increased its funds outstanding for foreign exchange, a big source of China’s money supply. In the period between January 2020 and September 2022, the amount of funds outstanding for foreign exchange, meaning using the Chinese yuan to buy foreign currencies from commercial banks by the country’s central bank, was 81 billion yuan (US$11.3b). By comparison, the amount of the funds in just seven months between October 2022 and April 2023 reached 476.8 billion yuan (US$66.7b). The injection of the Chinese yuan in the market pushed up supply of the yuan and pushed down its exchange rate.
The recent depreciation of the yuan is also an adjustment to its appreciation in late 2022. Starting in November last year, the Chinese yuan experienced over two months of rapid appreciation, as China implemented a series of stimulus policies. With high expectations of economic recovery, the yuan appreciated by 4.1 percent against the dollar in the last two months of 2022.
However, as recent figures show that economic activities have not recovered as quickly as expected, there was a general downward revision of the projected annual economic growth rate of China, which also drove down the yuan’s exchange rate.
Despite the drop in the yuan in recent months, one needs to be aware that the yuan’s exchange rate is still within the range of normal fluctuation. In the past few years, the yuan’s exchange rate against the dollar has experienced ups and downs. Looking back, the yuan’s current exchange rate against the dollar is at roughly the same level as in late 2019.
There is no reason to expect that the yuan will continue to depreciate in the medium or long term. At the 2023 Lujiazui Forum held in Shanghai on June 8, Pan Gongsheng, deputy governor of China’s central bank and head of the State Administration of Foreign Exchange, stressed that China’s foreign exchange market and its operations have been generally stable in 2023.
A major feature of China’s monetary policy is that it has taken a self-centered approach, focusing on both cyclical and internal-external balance, and it does not follow the Fed’s approach of hiking interest rates.
While this policy has put the yuan under pressure, it helps maintain the sustainability of China’s economic growth in the long run. Looking at the medium term, the Chinese yuan exchange rate is expected to regain strength. As the Fed’s interest rate hike cycle is expected to approach its end, its impact on capital flows is expected to weaken, and the yuan’s exchange rate could soon stabilize.
Moreover, the yuan’s exchange rate will primarily depend on China’s economic fundamentals. Although there may be some differences in market expectations on how much China’s economy will grow this year, China’s economic growth remains in better shape compared to other major economies.