The Yuan’s Slide Is Too Big for Beijing to Stop
The Yuan’s Slide Is Too Big for Beijing to Stop
China’s economy is faltering and so is its currency. The yuan’s drop to a two-year low has led to hand-wringing that emerging markets have lost an anchor. The slide is regarded with foreboding in Asia and trepidation as far away as Africa and Latin America, where China has sought to extend its commercial footprint. Bears are everywhere. That it has taken so long for alarm bells to ring says a lot about how the world grew accustomed to a China that for decades just powered along, even with a speed bump here or there.
The yuan declined for a sixth consecutive month in August. It’s down about 8% against the dollar this year and one of the worst performers in Asia this quarter. Sentiment is negative, according to Bloomberg’s MLIV Pulse survey conducted between Aug. 29 and Sept. 2. More than 60% of readers on the terminal and online predicted that the currency will weaken to 7.2 per greenback; it was 6.9 on Friday. Analysts are lining up to call the yuan lower. The depreciation is likely to weigh on the yen, Korean won, Thai baht and Malaysian ringgit, already hammered by aggressive hikes in US interest rates.
In some ways, this is gravity catching up with the yuan. China’s economy is struggling to grow; gross domestic product rose just 0.4% last quarter from a year earlier. Widely watched indexes of purchasing managers show factory activity is shrinking, credit growth is down significantly, retail sales are disappointing, and unemployment is mounting. Big urban areas have been shuttered to show commitment to Covid-zero. Last week, the metropolis of Chengdu, a major transportation hub, locked down its 21 million residents to contain an outbreak.
One consolation is that inflation is low by comparison with the US and Europe, which has given China’s central bank space to trim rates. Further policy easing is predicted this month. While helpful in putting a floor under the buckling expansion, that further erodes the appeal of the yuan, given the determination shown by the Federal Reserve to ratchet up rates to the point that households and businesses feel real pain. One of the primary drivers of any exchange rate is the gap in borrowing costs relative to major currencies. For all the power of the state and Beijing’s ability to nudge the yuan around, the government has no real interest in defying broad economic trends.
Sure, the People’s Bank of China does exert sway over the pace of yuan moves, adjusting the fixing that accompanies the start of the trading day to signal its desires. (On Monday, the fixing was stronger than expected for a ninth day.) Beijing can also be more forceful, as demonstrated late Monday when the PBOC slashed the amount of foreign-exchange deposits lenders need to set aside for reserves. It took a similar step in April after a rough month for the yuan. Such measures are best interpreted not as attempts to engineer a world-beating rally, but more as efforts to cushion the slide.
China's currency will appreciate when the economy is doing well, and will be inclined to head south when things don't look great. This was part of the deal when the PBOC ended a hard peg to the dollar in 2005. Not that the prospect of a retreating yuan got much attention then. The main criticism at the time was that it wouldn't provide for faster appreciation. The world was in thrall to China, gasping at every superlative that could be dished up. The economy grew 11.4% in 2005, on its way to exceeding 14% in 2007. These are more somber times. Growth had been steadily stuck in mid-to-high single digits for years; the pandemic pushed expansion down to 2.2% in 2020. After an impressive recovery last year, it’s again grinding lower and may be less than 4% in 2022, according to economists surveyed by Bloomberg.
The concern now expressed about emerging market currencies carries a faint whiff of the Asian financial crisis a quarter-century ago. Battered by higher interest rates in the US and a sagging Japanese banking system, markets tumbled. Another jolt awaited in the event China devalued the yuan as a way of protecting exports. Beijing held firm, but that fear nonetheless played a role in prompting the US to join Japan in propping up the yen in 1998. While China’s economy didn't sink during the region’s implosion, its breakneck pace of expansion did slacken to less than 8%.
The economy then was small relative to the behemoth it is today. It subsequently surged to become the world’s second biggest, and before Covid was widely predicted to knock the US off its top perch — in time. China’s strong rebound last year boosted demand in some Asian economies, helping them shake off the worst of a global slump. Now, the yuan reflects the erosion of growth prospects. Current anxiety is well placed — even if it’s been some time coming. The government’s clout in the foreign-exchange market can’t, and shouldn’t, cancel that discomfort.