My Take | Beijing likely to fiercely defend yuan exchange rate in 2025, as lessons from 2015 have been learned
The economic and political costs of a weakened yuan far outweigh the possible benefits China could gain from boosting exports
China’s central bank has reacted strongly to the depreciation of the yuan even though its weakening against the US dollar is modest compared to other Asian currencies, showing Beijing’s resolve to keep the exchange rate within its desired narrow range.
It seems the People’s Bank of China is extremely sensitive to the so-called threshold in both onshore and offshore yuan markets, and it is not hard to imagine that the central bank would not hesitate to escalate its countermeasures if the yuan started to test these key levels. It can increase market intervention when the rate moves closer to 7.4, and could tweak the yuan formation mechanism by adding “countercyclical” factors if the currency slides to 7.5. In the words of the central bank’s own newspaper, it has “sufficient tools and rich experience” in managing a depreciating yuan.
China will try its best to avoid a rapid yuan depreciation because it views the value of yuan versus the US dollar as almost a proxy of China’s economic soundness. The yuan-dollar exchange rate, not the complicated basket of currencies version, is the most visible indicator of how the world’s No 2 economy is doing in comparison to the world’s No 1 economy. In other words, it is not only an indicator with economic and trade implications but also a symbol of confidence and political commitment.
The exchange rate will be particularly important for 2025, as the gap between China’s nominal economic size and the US has widened if measured by the dollar. That means it will take much longer than previously expected for China to dethrone the US as the world’s No 1 economy. This is a fact directly at odds with Beijing’s vision that the East is rising and the West is declining. It could become an ideological inconvenience for China because the advantage of the country’s socialist system must be reflected in the unleashing of productive forces. In other words, the socialist system is better than capitalism because it can deliver faster economic growth.
China’s economy is expected to grow at about 5 per cent in 2025, compared to an estimated 2 per cent for the US. That means China can narrow the nominal GDP gap with the US as long as the yuan does not weaken significantly against the dollar.
Another important reason for Beijing to defend the yuan exchange rate is the shadow of events in August 2015, when the People’s Bank of China shocked the market by devaluing the yuan and shifted to a new exchange rate formation mechanism. The yuan’s depreciation, along with China’s stock market rout of that summer, triggered massive capital outflows and renewed scrutiny about China’s growth prospects. As a result, China’s foreign exchange reserves were depleted by US$1 trillion over about a year and a half through the end of 2016.
The last thing Beijing would like to see in 2025 is a repeat of the vicious cycle in 2015, when a modest depreciation of the currency triggered capital outflows and investment retreat. For a government that is trying hard to restore confidence in its broader economy, a large depreciation of the yuan – albeit “big” in Chinese terms – would throw a spanner into its overall strategy.
