The Yuan exchange rate (USD/CNY), which recorded an increase in 2022 and then stabilized, is showing a downward trend in the value of the Yuan (CNY) due to concerns over a slowdown/recession in the Chinese economy, including the real estate crisis, and the strengthening of the dollar due to the interest rate hike in the United States. It was the lowest level in 16 years.
I would like to learn about the weakening Chinese Yuan exchange rate and exchange rate policy.
Source: Investing.com (https://kr.investing.com/currencies/streaming-forex-rates-majors)
Table of Contents
Chinese Yuan Exchange Rate Trends
Since February 2023, the exchange rate has risen by more than 8% and the CNY value has continued to decline, and since August, the USD/CNY exchange rate has been maintained at a level of higher than 7.3, which is considered the Chinese authorities’ psychological Maginot line.
While China is cutting interest rates to prevent deflation, the United States is lowering interest rates to suppress inflation. Due to the widening interest rate gap between the United States and China, the acceleration of foreign investment funds leaving China is affecting the weakening yuan exchange rate.
The Chinese government has been strongly intervening in the market since mid-2023 to stabilize the USD exchange rate and has adopted various exchange rate defense policies.
- (August) Chinese Central Bank is encouraged to sell dollars and buy yuan.
- (Early September) Central bank cuts foreign currency reserve ratio by 2%
Inducing the effect of supplying foreign currency to the market by reducing the existing 6% → 4% (2006 level) (about $15 billion or more) - (Mid-September) The central bank issued exchange rate stabilization bonds worth CNY 15 billion in Hong Kong, absorbing Yuan liquidity and leading to an increase in the value of CNY offshore.
- (Late September) Prevent the interest rate gap from widening with the United States by freezing the Loan Prime Rate (LTR), which serves as the central bank’s standard interest rate.
- (October) Yuan exchange control due to ban on new overseas investments by mainland Chinese investors through offshore accounts such as Hong Kong
Despite these efforts, the market predicts that the Yuan will remain weak due to China’s economic slowdown.
China’s yUAN exchange rate policy in the past
- 1980: After reform and opening up, a dual exchange rate system was adopted to encourage exports and discourage imports.
– Different exchange rates are applied to trade/non-trade transactions. Since 1990, the gap between the two exchange rates has grown, leading to the formation of a black market and increased international criticism. - 1994: Introduction of the single exchange rate system and managed floating exchange rate system
※ However, as pressure to devalue the Yuan increased after the Asian foreign exchange crisis in 1997, a de facto fixed exchange rate system was restored in which the Yuan was pegged to the dollar. - 2005: Through the introduction of a basket-managed floating exchange rate system for multiple currencies, foreign currencies other than the dollar were also used as a reference in determining the base exchange rate.
- 2015: The previous day’s market closing price was weighted for foreign currencies in the currency basket and directly reflected in determining the CNY base exchange rate.
China is gradually attempting to transition from government-led planning management to supply-demand-based market control management through four major exchange rate policy changes since reform and opening up.
What is a managed floating exchange rate system?
– The central bank determines the base exchange rate by reflecting the latest onshore/offshore market exchange rates and the previous day’s market closing prices (weighted) of 24 baskets of foreign currencies.
– There is room for central bank intervention as the weights are not disclosed.
※ In the long term, the exchange rate is determined by supply and demand in the currency market, but the central bank intervenes in the foreign exchange market to prevent sudden fluctuations in the short-term exchange rate.
Countries such as Korea have adopted a freely floating exchange rate system.
YUAN Exchange rate trends by year
- From 1981 to 1983, the exchange rate was below 2.0
- It exceeded 2.0 in 1984 and continued to rise, surpassing 3.0 in October 1985.
- The exchange rate, which was around 3.2 in June 1986, rose to 3.7 in July.
- Afterwards, it maintained 3.7 until November 1989, then rose to 4.7 in 1989.
- It rose again to 5.2 in November 1990.
- Afterwards, it trended upward until the end of 1993, rising to 5.8.
- With the introduction of the single exchange rate system and managed floating exchange rate system in 1994, the formula rose to 8.7.
- Afterwards, there was a downward trend to the level of 8.3 until June 2005.
- Changed to 8.1 after the introduction of the foreign currency basket system in mid-2005
- Since then, the exchange rate has steadily fallen and the yuan has strengthened to the level of 7.0 in March 2008.
- After reaching the 6-point range in April 2008, it reached the 6.1 level in January 2014, and maintained the 6-point range until July 2019.
- It briefly rose to the 7-point range in the second half of 2019, then fluctuated back and forth between 6 and 7 points, and in 2023, it was mainly in the 7-point range.
For reference, in the past, when China expected a crisis such as a rapid rise in exchange rates, the government implemented policies to control the outflow of dollars and other funds abroad.
This is because if you purchase USD with CNY in China and remit it overseas, the supply of CNY increases and the demand for USD increases, causing the value of the yuan to fall further.
Accordingly, in the 2010s, especially after 2015 when the trade dispute with the United States intensified, the Chinese government implemented regulatory policies that made it more difficult for banks to make overseas remittances when necessary (e.g., stricter screening for overseas remittances of USD 5,000 or more). We managed the outflow of funds.
As a result, many foreign companies have faced criticism from the international community as it has become cumbersome to send funds to their headquarters, and many Chinese people have been restricted from purchasing overseas real estate to purchase safe assets overseas.
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