China cites ‘flexible’ yuan exchange rate, healthy economy as buffer against US tapering

China’s advanced economy and the flexibility of its yuan exchange rate leave it well placed to absorb shocks from policy tightening by the US Federal Reserve, including hot money flows out of the country, the nation’s currency regulator has said.

The assurance from China’s State Administration of Foreign Exchange (SAFE) comes as the Federal Reserve inches closer to reducing monthly asset purchases and, possibly in 2023, raising interest rates.

The prospect of US monetary tightening has evoked memories of the Federal Reserve’s policy moves in 2013, which resulted in investor flight from emerging markets and a depreciation of the yuan, a situation nicknamed the “taper tantrum”.

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“We have accumulated a lot of experience and policy tools, and have taken many pre-emptive actions this year,” said Pan Gongsheng, administrator of SAFE and deputy-governor of the People’s Bank of China (PBOC), at the Financial Street Forum in Beijing on Wednesday.

What does a stronger US dollar-yuan exchange rate mean, and why is Beijing worried?

“The yuan exchange rate will be basically stable at a level of equilibrium ... as its flexibility improves, it can play a better role in self-adjustment.”

Pan said the impact of US tapering was controllable because of China’s solid economic fundamentals, well-balanced international payments, and macroprudential adjustment tools.

His comments reinforced market expectations the central government will be less willing to directly intervene in the foreign exchange market, allowing for greater volatility.

Chinese authorities have already signalled willingness to accept more foreign exchange volatility. A year ago, the PBOC removed the countercyclical factor from the formula used in daily exchange rate management, which was adopted in 2017 to curb speculation and rapid changes in the yuan’s value.

Pan attributed stress on the yuan to one-way appreciation between 2005 and 2014 and the rise of the US dollar index against rival currencies, but said he saw less of such pressures this time.

“In the current round of policy tightening, the gap between the US and other economies is apparently smaller in terms of growth and monetary policy. This will affect the room of US dollar appreciation,” he said.

The US dollar index has increased 0.7 per cent to 93.56 since mid-August, when market expectations of US tapering began to grow.

The yuan has turned more volatile in the past two years. It fell below 7 yuan per dollar at the end of 2019, but bounced back to 6.3572 yuan per dollar in June.

On Thursday, the daily midpoint reference for the yuan was set by the central bank at a four-month high of 6.3890.

The yuan is allowed to rise or fall by 2 per cent on either side of the daily parity, which the PBOC often uses to signal to the market its stance for the currency.

China International Capital Corporation attributed the recent strengthening of the yuan to a weaker US dollar, the country’s strong exports and capital inflows.

However, “from a medium and long-term perspective, the yuan is unlikely to have persistent appreciation,” it wrote in a note on Tuesday.

Chinese regulators launched a crackdown on foreign exchange market manipulation in late May, warning exporters they must stay neutral to risk. Last month, SAFE urged companies to better manage their foreign exchange exposure and use hedging tools.

It has also enhanced macroprudential assessment of cross-border capital flows and is keeping a close eye on foreign exchange transactions.

The world’s second largest economy remains an investment hotspot after it successfully contained the initial coronavirus outbreak and the industrial sector quickly recovered its role as the globe’s main producer of consumer goods.

China attracted US$110.8 billion of foreign direct investment in the first 10 months of this year, up 2.9 per cent from a year earlier.

Meanwhile, foreign investors raised their holdings of Chinese bonds for 34 straight months over the same period by 88 billion yuan (US$13.7 billion) to 3.47 trillion yuan last month.

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