Guan Tao says RMB's recent rise is market-driven
Guan Tao says RMB's recent rise is market-driven
The former DG of Balance of Payments at SAFE doubts that the yuan will continue strengthening and advises Beijing to plan for different scenarios in the U.S. economy.
As I shared a bit earlier, the Tsinghua PBCSF (People’s Bank of China School of Finance) Chief Economists Forum on Saturday, September 28 in Beijing gathered leading Chinese economists who shared their insight.
The following are the remarks by Guan Tao, Chief Global Economist with Bank of China International Holdings Co., Ltd (BOCI) Securities and former Director-General of the Balance of Payments Department of China’s State Administration of Foreign Exchange (2009-2015).
Tsinghua PBCSF, where I had the privilege to attend a non-degree scholarship program for journalists, provided a Chinese transcript of all the remarks at the forum.
Recently, the exchange rate of the Renminbi (RMB) has been a hot topic. I would like to share three points regarding the Federal Reserve’s interest rate cuts and the RMB exchange rate.
First, this recent rebound in the RMB exchange rate is market-driven.
Why do I bring this up? Many people are asking, given the current state of China's economy, why is the RMB still appreciating? Why haven't relevant authorities taken measures to curb the appreciation, especially before the financial support package was introduced on September 24th?
I want to clarify that this rebound in the RMB is not something deliberately guided by the authorities. Since July 25th, we have observed a steady upward trend in the RMB exchange rate. So far, both the central parity rate and the onshore/offshore exchange rates of the RMB have recovered all the losses incurred earlier this year, with the rate climbing near 7.0. As of yesterday, the offshore RMB rate has officially broken below 7, while the onshore RMB remains around 7.01.
Why do we say this appreciation is market-driven? After the RMB appreciated on July 25th, the central parity rate remained consolidating at a low level for quite some time. The market often views the central parity rate as a key indicator of the central bank’s exchange rate policy. However, as of August 13th, the central parity rate reached a new low for the year, despite the RMB beginning to rebound on July 25th. Moreover, during this rebound, the RMB Exchange Rate Index also depreciated relative to earlier periods. In other words, while non-U.S. currencies generally appreciated against the dollar, the RMB’s appreciation lagged behind the overall appreciation of other non-dollar currencies. This shows that the current appreciation is being driven by the market.
One other interesting point: before the policy package was introduced on September 24th, there had been widespread debate about China’s economy, with many differing opinions. However, this round of RMB appreciation actually began before September 24th. In fact, the onshore RMB exchange rate broke through 7.1 as early as September 13th, well before the introduction of the new macroeconomic policies. This suggests that the RMB’s appreciation had already fully priced in the market’s expectations of China’s economy before September 24th. That’s the first point.
Second, do not hastily declare a new cycle; instead, adapt to the new normal.
Some people are now speculating whether the RMB has entered a new appreciation cycle, similar to the discussions that arose after the RMB appreciated in 2020. Why do I say not to hastily declare a new cycle? We need to understand that this wave of RMB appreciation is driven by two factors. Initially, it was fueled by external factors, such as expectations of easing by the Federal Reserve, a weakening dollar, and a sharp rebound in the yen, which in turn led to the RMB's appreciation through the unwinding of carry trades. Whether the RMB will continue to appreciate depends on changes in the external environment.
Additionally, after September 24th, China introduced a new round of financial support plans, and at the September 26th Politburo meeting, it was announced that further fiscal and monetary support would be forthcoming. As a result, there is now a great deal of anticipation for increased fiscal stimulus, which has been reflected in the foreign exchange market. However, compared to the stock market, the forex market is still relatively small. As Dean Tian mentioned in his speech, the stock market was surging, with the Shanghai Composite Index gaining over 10% in the past week.
So, whether the RMB will continue to appreciate depends on the sustainability of these two factors. Regarding domestic economic improvements, this will depend on the implementation of additional monetary policy and the follow-up of fiscal policy. The key question is whether these two policies can work together to stabilize growth. Based on the current situation, these policies are primarily aimed at achieving the annual economic growth target of around 5% set at the beginning of the year. The next question is whether this 5% growth rate will be enough to sustain a one-way appreciation of the RMB.
Even if China achieves around 5% growth, it would certainly provide stronger support for the RMB than before; however, will it lead to a one-way appreciation? If we look at the experience during the Asian Financial Crisis, in 1998 and 1999, when China’s economy failed to achieve the 8% growth target, that was when the RMB faced the greatest depreciation pressure. Even after the economy recovered to over 8% growth in 2000, the RMB still faced downward pressure until the U.S. economic recession in 2001, when the Federal Reserve significantly cut rates and the dollar began a weakening trend. Only then did we see capital inflows and the RMB appreciation pressure, which wasn’t realized until the exchange rate reform of July 21, 2005. Prior to that, the appreciation pressure primarily manifested as capital inflows and a rapid accumulation of foreign exchange reserves.
Therefore, we must not only focus on China’s economic performance but also consider the U.S. economy and the Federal Reserve’s monetary policy. Although the Fed initiated its first rate cut of 50 basis points this September, Powell has made it clear that this should not be seen as the new normal. He has indicated that future rate cuts could accelerate, slow down, or even pause entirely, depending on the economic scenario. This corresponds to three possible outcomes for the U.S. economy: a soft landing, a hard landing, or a no landing, where inflation risks persist.
In my opinion, following the start of this rate cut cycle, the U.S. economy faces three possible outcomes: a soft landing, a hard landing, or no landing. In a soft landing, the Fed would continue with gradual, intermittent small rate cuts. In a no landing scenario, the Fed could pause rate cuts or even restart rate hikes, similar to Greenspan’s actions in the mid-1990s. In such a scenario, the dollar could strengthen again, putting pressure on the RMB. Only in a hard landing scenario would the Fed implement significant rate cuts, leading to a weakening dollar once risk aversion subsides, which could support the RMB.
Therefore, there are still many uncertainties both internally and externally. As a result, I believe the RMB exchange rate is shifting from a one-way trend to a more two-way fluctuation.
Third, I’d like to offer some policy suggestions.
Two points:
First, from a government perspective, as we’ve discussed, the Fed’s monetary policy path and the U.S. economic outlook remain highly uncertain. Regardless of the outcome, it will have both advantages and disadvantages for China. We often mention the rising complexity, severity, and uncertainty of the external environment, and this was reiterated at the Politburo meeting in late July.
When facing such external challenges, I believe preparation is more important than prediction. Rather than predicting whether the U.S. economy will achieve a soft landing or how the Fed will cut rates, we should focus on what actions we need to take under different scenarios and have policies ready in advance.
What do I mean by contingency planning? It means conducting scenario analyses in advance and setting up thresholds for different situations. Once a threshold is triggered, we can roll out appropriate policies in a timely manner, improving our response capability. It’s not about waiting for events to unfold and then figuring out what to do. By that time, we would only be making marginal adjustments to the pre-existing contingency plans.
Second, from the perspective of businesses, in an environment with both internal and external uncertainties, companies should further strengthen their awareness of risk neutrality, controlling currency mismatches and exposure to exchange rate fluctuations. In the past, when the U.S. had zero interest rates and unlimited quantitative easing, many discussed the availability of cheap funds abroad. But then, high inflation returned unexpectedly, and the Fed responded with aggressive rate hikes. Now, everyone has learned their lesson: are cheap funds still available abroad? Many foreign-dollar debt positions have suffered as a result.
The same applies now. Many are fixated on the idea of the RMB being a low-interest currency and are reluctant to sell dollars, engaging in interest rate arbitrage and profiting from both the interest rate and appreciation spreads. However, if the RMB experiences short-term volatility, the price at which you convert your currency may not be as favorable as you expect. Therefore, businesses not in the financial sector should focus on their core operations and use appropriate tools to hedge against exchange rate risks.
