Coronavirus: is China re-pegging the yuan to the US dollar to avert a financial crisis?
- In the aftermath of the global financial crisis, the People’s Bank of China (PBOC) effectively held the exchange rate at 6.83 from late 2008 until June 2010
- Amid the current economic and financial environment, a PBOC official said late last month that the yuan would fluctuate around the level of 7 yuan ‘in the future’
China’s central bank may be re-pegging the yuan’s exchange rate against the US dollar to avert the threat of a financial crisis and create a sense of stability amid the huge economic and financial uncertainties resulting from the coronavirus pandemic, according to analysts.
While the central bank has never publicly admitted that it would peg the yuan to the US dollar, in the current economic and financial environment, Chen Yulu, a deputy governor at the PBOC, said late last month that the yuan would fluctuate around the level of 7 yuan “in the future”.
PBOC leaders have hinted they may be targeting seven. Although we are not sure how a stronger currency helps in a post-Covid-19 adjustment
“PBOC leaders have hinted they may be targeting seven,” said Cliff Tan, East Asian head of global markets research at MUFG Bank. “Although we are not sure how a stronger currency helps in a post-Covid-19 adjustment”.
Analysts said the phase one trade deal signed with the United States in January also included an exchange rate provision that prohibits competitive currency depreciation.
“Since the environment has turned into quite an emergency now, [the PBOC] is using moral suasion to boost confidence and anchor expectations for the currency,” said DBS Bank economist Nathan Chow. “There can be no sharp and rapid depreciation in the yuan now since that would make matters worse.
“Once you start pegging the currency, fund managers and traders will continue to speculate when you will do it again the next time. This would reverse previous reforms to make the yuan [exchange rate] more market driven.”
The yuan plummetted to 7.16 against the US dollar in mid-March, its weakest level in five months, amid a crash in global stock markets as investors scrambled for the perceived safety of US dollar assets. But the Chinese currency has stabilised in the past week or so and traded at 7.07 on Thursday.
“The PBOC needs to provide currency stability to the region like it did in [the Asian financial crisis of] 1997 and [global financial crisis of] 2008. But it also needs to tolerate some fluctuation,” said HSBC in a research note. “This is to preserve the achievements of exchange rate reforms since 2015 and accommodate wider cross border portfolio flows.”
China has a long tradition of pegging the yuan to the US dollar. It maintained a hard peg of 8.38 from 1995 to 2005 amid the country’s export boom. In July 2005, Beijing revalued the yuan by 2.1 per cent and announced reforms of its exchange rate regime by adopting a “soft peg” that allowed a managed, floating exchange rate.
The yuan’s rise against the US dollar peaked in late 2013, when it entered a depreciation cycle. Beijing’s surprise devaluation by nearly 3 per cent against the US dollar in two days in August 2015 was also said to be a measure towards free market reforms which led to greater market volatility. In 2018, the yuan fluctuated within a relatively large range of 11 per cent.
The yuan has outperformed many of its peers since the outbreak of Covid-19. For many, this is reminiscent of China's ‘crisis mode’ foreign exchange policy as during the 2008 global financial crisis
“The yuan has outperformed many of its peers since the outbreak of Covid-19. For many, this is reminiscent of China's ‘crisis mode’ foreign exchange policy as during the 2008 global financial crisis, as the yuan was basically pegged to the secure US dollar,” said Stephen Innes, chief global market strategist at AxiCorp.
“It tells me [China] tried to keep the yuan in check with the strong US dollar to avoid capital outflows and maybe that is the objective to a degree again during the Covid-19 scare.”
The PBOC may need those foreign reserves to bail out the domestic banking system if the deterioration of the real economy is compounded into a financial crisis.
After keeping its reserves stable at around US$3.1 trillion in recent years, China’s holdings fell US$46.085 billion in March, the biggest drop since November 2016, with the total falling to a 17-month low of US$3.061 trillion.
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