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China is trying to shore up an economy growing at its slowest pace since 1990.
China is trying to shore up an economy growing at its slowest pace since 1990.

China’s Currency Dilemma Deepens

China’s Currency Dilemma Deepens

As the yuan plumbs new lows against the US dollar, China’s currency is still strengthening against peers.

That’s posing a dilemma for the nation’s policy makers as they seek to arrest a plunge in exports and shore up an economy growing at its slowest pace since 1990, Bloomberg reported.

China’s exchange rate climbed 0.6% against a trade-weighted basket last week, its biggest advance in three months, even as it slumped 0.8% versus the US dollar to a six-year low. Against the euro and the South Korean won, the yuan gained at least 0.7%.

With the latest data showing Chinese outbound shipments sank 10% last month from a year earlier, the case for a weaker currency is growing. The quandary for policy makers is how to allow a quicker pace of depreciation against the US dollar without sparking the size of capital outflows that occurred in January this year and August 2015.

“Given the current strong US dollar environment, it would be difficult to see the basket weaken,” said Perry Kojodjojo, a strategist at Deutsche Bank AG in Hong Kong. “At the end of the day, if you want exports to be more competitive because of your currency, then you need the currency to be weak, but the problem is that that would create systemic risks, which the People’s Bank of China authorities would likely feel uncomfortable with.”

The risks of a faster depreciation were laid bare in August last year, when policy makers unexpectedly devalued the currency. After a more than 50% surge in the real effective exchange rate over the past decade, there was a compelling case to weaken the yuan. The result, however, was panic across global markets and record capital outflows, which prompted the government to deplete its foreign-exchange reserves to stabilize the exchange rate and tighten controls on outflows.

The yuan fell 0.1% to 6.73 per dollar in Shanghai, while dropping 0.1% against the trade-weighted index.

“Exports remained sub-par for China and for most other parts of the world,” she said. “Hence, the benefits of depreciating the yuan on a trade-weighted basis is small and would be largely outweighed by a potential rise in capital outflows should markets expect the yuan to weaken substantially.”

Still, the slide in exports will add to pressure for policy makers to allow quicker depreciation, said Deutsche’s Kojodjojo. “Given the weaker data, China is likely to try to correct some of the renminbi over-valuation,” he said, using an alternative name for the currency.

 

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