Is the RMB exchange rate constantly falling? Trade | RMB | Exchange Rate

7.0, 7.1, 7.2... Recently, the exchange rate of the Chinese yuan against the US dollar has continued to weaken.

On June 26th, the offshore Chinese yuan fell below 7.23 against the US dollar, setting a new low since November last year; At around 16:00 on June 28th, the offshore RMB fell below the 7.25 mark against the US dollar.

On the evening of the 28th Beijing time, Powell hinted at a central bank forum group discussion held by the European Central Bank that the Federal Reserve may raise interest rates in July and September.

On June 29th, the offshore Chinese yuan continued to decline against the US dollar, falling by 7.26 points again and falling more than 200 points within the day.

Since mid April, the RMB exchange rate has depreciated by approximately 5.3%.

What are the impacts of the downward trend of the RMB exchange rate? What is the reason? When will the decline stop?

01

Impact on A-shares?

Will a decline in exchange rates cause a decline in A-shares? Many investors have such doubts.

Fuguo Fund once counted the RMB exchange rate and major A-share indices since the exchange rate reform in 2015, and found that during the period of RMB appreciation, the major A-share indices generally rose; During the depreciation phase of the RMB, major A-share indices generally fell.

However, further analysis by Fuguo Fund shows that the linkage between the two is often the result of changes in China's economic expectations and US dollar liquidity expectations.

In other words, the two are not causal, but rather co causal. It is not the depreciation of exchange rates that leads to a decline in the stock market, but rather some factors that result in both exchange rate depreciation and a simultaneous decline in the stock market.

What factors affect exchange rates?

"At present, the trend of RMB exchange rate fluctuations that we see is mainly dominated by supply and demand," said Zhao Xijun, Co Dean of the China Capital Market Research Institute at Renmin University of China, but the influencing factors are very complex.

From the perspective of international balance of payments, the weakening of trade is a major reason.

For a long period of time, China's exports of goods were mainly from the US market, followed by the European Union. Recently, Western countries have been continuously promoting "disconnection and decoupling", which undoubtedly has a certain degree of impact on China's trade. Nowadays, the market share of the United States has dropped to third, and ASEAN has become China's largest trading partner.

"From the perspective of total trade volume, it is still basically stable, but structural changes are occurring, significantly affecting exchange rate fluctuations due to changes in the US surplus." Zhao Xijun said.

Internally speaking, the main reason for the slower than expected recovery of domestic economic fundamentals or the recent weakness of the renminbi.

According to the macro data of the National Bureau of Statistics, the cumulative year-on-year growth rate of fixed assets investment fell from 4.7% in April to 4.0% in May, the year-on-year growth rate of exports denominated in dollars fell from 8.5% in April to -7.5% in May, and the year-on-year growth rate of total retail sales of consumer goods fell from 18.4% in April to 12.7% in May.

Capital flows also lead to changes in the RMB exchange rate.

On the one hand, the inverted interest rates between China and the United States, as well as the expected divergence of monetary policies between China and the United States, have led to international capital flows.

On the other hand, China is accelerating its transition from attracting foreign investment to investing abroad, and there is also some downward pressure on the RMB exchange rate.

According to data released at the regular press conference of the Ministry of Commerce in mid June, China's outward investment continued to grow from January to May 2023, with non-financial direct investment of 356.46 billion yuan, a year-on-year increase of 24.2%.

02

Positive export?

Logically speaking, if the exchange rate of the Chinese yuan depreciates, the US dollar can purchase more Chinese products, which is beneficial for exports.

What is the actual situation?

A manager named Xia, who has been engaged in the foreign trade industry for more than 10 years, told reporters that due to the current low global economy and demand, foreign customers are more cautious and have not experienced a significant increase in orders due to exchange rate fluctuations.

"Even if some foreign wholesalers had stocked up a little bit earlier, the slow sales resulted in slow return orders," Manager Xia admitted.

The financial manager of a large service trade enterprise in the province revealed that for stable trade enterprises, they will not allow exchange rate risks to "run naked". Generally, they will hedge the financial risks caused by exchange rate fluctuations through forward exchange rate locking and other methods. In this case, they cannot enjoy the excess exchange settlement returns brought by the downward trend of the RMB exchange rate.

"In addition, in the face of the downward trend of the RMB exchange rate, some strong foreign investors often require companies to make additional concessions on export product prices to offset this additional exchange rate gain." The financial manager believes that in such a situation, the downward exchange rate of the RMB against the US dollar may not necessarily be beneficial for exports.

"The current RMB exchange rate still exhibits frequent and significant short-term fluctuations," Zhao Xijun believes, which brings financial risks to many market entities such as importers and exporters, investors, and foreign exchange financial institutions.

He suggested that in the face of exchange rate fluctuations, enterprises and financial institutions should continuously improve their ability to manage exchange rate risks, focus on liquidity risk control and asset liability matching, especially financial institutions should learn from the experience of the "Southeast Asian financial crisis" to avoid exchange rate system risks.

"The internationalization of the RMB is becoming increasingly important." Zhao Xijun believes that the government should continue to optimize the RMB settlement environment for cross-border trade and encourage enterprises to use the RMB for cross-border business.

According to data from the International Department of the People's Bank of China, the scale of cross-border RMB settlement in goods trade increased by 37% year-on-year in 2022, accounting for 19%, an increase of 2.2 percentage points from 2021.

"This may also be a painful period in the process of RMB internationalization. As a foreign trade enterprise, we also hope that the RMB can have more say in the international market. Only with the long-term stability of the RMB exchange rate can our development be more secure." said the financial manager of a large service trade enterprise in the province.

03

What is the future trend?

To analyze the future, let's first talk about history.

Before the reform and opening up, all foreign exchange income must be sold to the state, and foreign exchange must be allocated in a planned manner; We basically do not borrow external debt and do not accept foreign investment in China; The RMB exchange rate is only used as an accounting tool.

Therefore, most people are "insensitive" to the fluctuation of the RMB exchange rate.

Our current exchange rate system was gradually reformed and improved after the Third Plenary Session of the Eleventh Central Committee of the Communist Party of China. Especially with the significant reforms in early 1994, China established a single, managed floating exchange rate system based on market supply and demand, and established a unified and standardized foreign exchange market.

"In 1994, the exchange rate between the US dollar and the Chinese yuan was 8.7 yuan, which has remained at around 1:7 in recent years. With the enhancement of China's comprehensive national strength and the active and prudent intervention of the central bank, in the long run, the Chinese yuan has maintained a steady appreciation." Zhao Xijun said.

However, in recent years, with the introduction of new cross-border securities investment mechanisms such as the "Shanghai Hong Kong Stock Connect", "Shenzhen Hong Kong Stock Connect" and "Bond Connect", China's financial market is opening wider and wider, and the exchange rate changes are increasingly affected by the international market.

"The People's Bank of China and foreign exchange management departments' tolerance for exchange rate fluctuations is constantly increasing, and in the short term, they will not intervene in exchange rates," Zhao Xijun told reporters.

Chen Xing, Chief Macro Analyst at Caitong Securities, believes that the central bank may still be optimistic about the prospects of the RMB exchange rate. Against the backdrop of the Federal Reserve's interest rate hike cycle coming to an end and China's economic growth potentially bottoming out and rebounding, the RMB exchange rate is likely to rise but not depreciate in the medium to long term.

Chen Xing said that this also means that the policy space of China's central bank is relatively sufficient. Once the exchange rate changes exceed the estimate, there are still sufficient tools to respond. Therefore, if the trend of the US dollar reverses or the central bank takes action, or triggers a turning point for the appreciation of the RMB exchange rate.

"From the perspective of the monetary policy expectations of both countries, China has a clear guidance for the downward trend of RMB interest rates, and although the Federal Reserve has suspended interest rate hikes, it has not announced the abandonment of interest rate hikes. The subsequent choices of the Federal Reserve will have a significant impact on the exchange rate." Zhao Xijun analyzed that the current inflation level in the United States has fallen significantly, and the Federal Reserve's interest rate hikes may be nearing their peak, and a turning point may appear within the year.

The strategy research team of China Merchants Securities analyzed that as long as US inflation no longer exceeds expectations, the space for further exchange rate adjustments is relatively limited. If the market's expectations for the domestic economy and policies continue to improve, it is expected to guide the RMB to shift towards appreciation.