New Delhi has witnessed a significant development in the global financial arena. The Chinese yuan has been on a downward trajectory since the victory of U.S. President-elect Donald Trump. Finance experts are now closely observing the actions of the Chinese government in defending the currency.
Unraveling the Mystery Behind the Yuan's Slide and Its Implications
Background and Initial Drop
The Chinese yuan has been steadily slipping against the U.S. dollar even before the U.S. election on November 5. In a seven-week losing streak, it dropped more than 3%, reaching a closing value of 7.23 to a U.S. dollar on Tuesday, compared to 7.09 on Election Day. This decline reflects the negative expectations in the world towards China-U.S. relations after Trump's victory and some misperceptions in the international market about China's growth.As Mark Williams, chief Asia economist at London-based Capital Economics, pointed out, "There's been a broad strengthening of the dollar over the past few weeks which is in part a response to Donald Trump's election victory but also to stronger U.S. economic data. Both developments have led investors to pare back expectations for rate cuts by the U.S. Federal Reserve."Export Strategy and Currency Depreciation
Some economists believe that Beijing deliberately allowed the currency to slide to boost China's export prospects. With Trump promising to impose a 60% tariff on all Chinese goods, a weaker currency acts as a safety valve. It makes the country's exports cheaper and offsets the impact of the tariff.China's policymakers have a substantial reserve of $3.26 trillion, providing a strong cushion against shocks. However, they prefer not to use a large portion of it to defend the yuan. As Benn Steil, a senior fellow and director of international economics at the Council on Foreign Relations, said, "The PBoC [Bank of China] will not wish to burn through its foreign reserves in a doomed effort to keep the RMB at current levels. The PBoC can slow RMB depreciation, but market pressure will eventually win out — if not in the coming weeks, in the coming months."Trump's plans to impose massive tariffs will keep U.S. interest rates higher, reducing U.S. demand for foreign currency to pay for imports. This will push up the value of the dollar and push down the value of the currencies of U.S. trade partners, including China.But Wang Wen, dean of Renmin University's Chongyang Institute for Financial Studies, believes that the yuan will absorb the initial shock and start to rise after next year. "At present, the competition between China and the United States has reached a critical period. But China will not lose in the longer term and the yuan will begin to appreciate. Time is on China's side."Risk of Declining Yuan
A weak yuan not only reduces confidence in the Chinese economy among foreign investors but also hampers Beijing's long-standing effort to internationalize its currency. Goldman Sachs expects China's exports to fall 0.9% next year in nominal dollar terms due to higher tariffs. However, it also expects the yuan to weaken to 7.50 per dollar by the end of 2025, with the tariff impacts partially offset by domestic easing and currency depreciation.The biggest risk for China is an accelerating capital flight as Chinese residents lose confidence in the domestic economy. As Steil pointed out, "This will hurt China's ambition of boosting household domestic consumption, which is the only way to stabilize the Chinese economy in the medium term."