The Chinese Communist Party is facing challenges in its currency policy, with Beijing being vigilant about any major fluctuations in the forex market. In order to alleviate tariff and economic pressures, the Renminbi needs to depreciate, but the accompanying risk of capital outflow cannot be ignored.
Recently, Beijing allowed the Renminbi to fall below the key level of 7.3 against the US dollar, the lowest level since September 2023. According to the daily reference rate set by the People’s Bank of China, the Renminbi is only allowed to fluctuate within a 2% range around the specified reference rate.
Due to the increasing gap in interest rates between China and the United States, the Renminbi has been under pressure. The Chinese and American economies are moving in opposite directions, with US Treasury yields rising – attributed to market expectations of fewer rate cuts by the Federal Reserve and the potential inflationary policies of the Trump administration, while Chinese bond yields have dropped to historical lows due to the economy teetering on the brink of deflation. Currently, the yield on US 10-year Treasury bonds is approximately 3.1 percentage points higher than that of China, compared to a gap of around 1.4 percentage points a year ago.
The looming trade war will also exert pressure on the Renminbi. During Trump’s first term, the Renminbi depreciated by about 10% against the US dollar.
The devaluation of the Renminbi can to a certain extent offset the impact of tariffs on Chinese exports, which are crucial for the Chinese economy given the sluggish domestic consumption demand.
However, Renminbi depreciation can also lead to capital outflows, a concern that troubles Chinese authorities. Beijing fears a repeat of the massive capital outflows seen in 2015, which dealt a blow to the economy. In 2015, in response to weak domestic economic conditions, the authorities allowed a sudden 3% devaluation of the Renminbi against the US dollar, which exacerbated capital outflows. Between 2014 and 2017, China’s foreign exchange reserves decreased by nearly $1 trillion.
Bloomberg analysis suggests that Beijing is adopting a wait-and-see approach towards Trump’s potential tariff policies, which may allow for further Renminbi depreciation, though not to a degree sufficient to offset the impact of tariffs, especially considering Trump had proposed tariffs as high as 60%.
The Financial Times reported that many economists believe Beijing is delaying the rollout of further stimulus measures, waiting for clearer policy direction from the US after Trump’s inauguration.
Julian Evans-Pritchard, director of China economics at the UK research firm Capital Economics, stated that the People’s Bank of China has “no good options left.” He pointed out that the central bank may have to accept a certain degree of currency weakness, but the question remains: where is the bottom line?
Simultaneously, Beijing’s capital controls could face their biggest test since 2015.
Craig Chan, a strategist at Nomura Securities, noted in a report: “When the spot price of Renminbi approaches the lower limit of the daily fluctuation range, concerns about Renminbi depreciation may trigger forex hoarding behavior and prompt state-owned banks and official entities to inject more forex supply into the market.”
He further wrote: “While some tariff risks may have been absorbed by the market, if Trump announces an additional 10% tariff on Chinese goods on inauguration day, the offshore Renminbi exchange rate against the US dollar may hit new highs.”
Bloomberg concludes that Beijing currently faces no simple solutions amidst a weak domestic economy and escalating external challenges.