China Allows for Stronger Yuan as Xi Turns Focus to Home

The two reasons why China is allowing a stronger yuan.

China Allows for Stronger Yuan as Xi Turns Focus to Home
Chinese one-hundred yuan banknotes in Hong Kong, China. (Photographer: Paul Yeung/Bloomberg)

Beijing is allowing faster gains in the yuan as it seeks to cheapen imports and bolster weak consumer spending.

That’s one theory touted by DBS Bank Ltd. and Mizuho Bank Ltd., who say a stronger yuan is ideal for Beijing at a time when Chinese President Xi Jinping is pushing for a more self-reliant economy. That marks a shift from when officials worried that a strong yuan would undercut the nation’s exports to the world.

The daily currency fixings show China’s equanimity toward accelerating gains in the yuan, with the central bank refraining from sending clear warning signals to traders. That’s even as the yuan gained nearly 5% since late May versus the dollar to its highest level in more than a year. The fixings -- - a tool the PBOC often uses to limit currency strength -- have generally been tracking the market higher as the dollar has weakened.

China Allows for Stronger Yuan as Xi Turns Focus to Home

A stronger exchange rate also helps remove a flashpoint in relations with the U.S., with President Donald Trump having long accused China of keeping the yuan artificially weak. Additionally, domestic banks will be more inclined to hold a currency that isn’t depreciating, which in turn would help Beijing reduce the financial sector’s reliance on the greenback.

“Tolerance toward a stronger yuan when it is fundamentally driven is going to be high,” said Wang Ju, director and senior foreign-exchange strategist at HSBC Holdings Plc in Hong Kong. “A stronger yuan would help China diversify away from the dollar and optimize its resource allocation.”

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The currency’s rally since this year’s nadir in late May has made it one of the best performers in Asia, with the buying momentum still standing close to the strongest since January. The yuan’s large interest-rate premium over the yield on the dollar also helped to boost demand.

Such strength is already helping China, which was reported to be buying a record amount of American soybeans this year as lower prices help it boost purchases pledged under the trade deal. But still, the economy remains fragile -- the country’s imports contracted in all but one month since March, while retail sales came out worse than economists had expected for five months in a row.

“The stronger yuan could stimulate imports and further expand the domestic consumption market,” said Ken Cheung, chief Asia currency strategist at Mizuho. “China’s leaders will be less tempted to use depreciation to stimulate the economy, as the export sector plays a secondary role in growth now.”

But this doesn’t mean Beijing will let the yuan run wild. A key indicator of strength is the CFETS RMB Index, which tracks the yuan against 24 peers. It shows the yuan has appreciated about 2.3% against them since the start of August.

The central bank may set the fixing at weaker-than-expected levels if the gauge jumps rapidly to a point where the strength eats into exports, said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd.

The yuan last traded at 6.8396 per dollar.

But for now, the yuan has room to advance further said Ong, who sees demand for the greenback being reduced after the U.S. presidential election in November. “A stronger yuan is a better fit for China’s growth model,” he said, predicting the currency to hit 6.7 per dollar by year-end.

©2020 Bloomberg L.P.

With assistance from Bloomberg