Rapid rise of yuan unsustainable

The recent rapid appreciation of the renminbi shows that exchange rate overshooting may have taken place. Looking ahead, this phenomenon is unsustainable and does not meet the economic and financial situation at home and abroad, said a former official of the People's Bank of China, the nation's central bank.

The spot exchange rate of the renminbi against the US dollar has risen 8.2 percent since the second half of last year, said Sheng Songcheng, adjunct professor of economics and finance at China Europe International Business School and former director of the People's Bank of China's statistics and analysis department. The rate stood between the 6.3 and 6.4 levels recently.

"The appreciation of the renminbi against the US dollar cannot be used as an instrument to counteract the effects of commodity price increases. As commodities usually adopt a global pricing strategy, the appreciation of the renminbi to a certain degree will have little impact on commodity prices. The latest round of commodity price increases are caused by the relationship between supply and demand (which means the demand for commodities exceeds supply), as well as market speculation. It is impossible to be restrained through the appreciation of the Chinese currency," Sheng said during an interview with Xinhua News Agency on Sunday.

Besides, renminbi exchange rate overshooting is a short-term speculative behavior that is unsustainable. While China adheres to opening-up and encourages long-term investment, the country should prevent large inflows of short-term capital, which will push up the renminbi exchange rate, weaken the competitiveness of export companies, and disrupt China's financial market and the independent implementation of its monetary policy, he said.

The US economic recovery from the COVID-19 pandemic also will affect renminbi exchange rates. The US dollar may strengthen, as the US economy will hopefully rebound comprehensively in the second half of this year. At the same time, interest rate spreads between China and the US will make a transition from drastically widening to narrowing. Therefore, the influx of hot money in China may weaken to some extent.

Currently, the 10-year treasury yield spread between China and the US has narrowed down to 1.5 percentage points from 2.5 percentage points in mid-November, and there is still room for improvement on the yield on the 10-year US treasury note, he said.

China has sufficient policy instruments to deal with the short-term surge in capital inflows. The People's Bank of China has taken necessary policies and reform measures to keep the renminbi exchange rate at a reasonably stable equilibrium since October, he said.

Starting from Oct 12, the PBOC has cut the reserve requirement ratio for financial institutions when conducting foreign exchange forwards trading from 20 percent to zero. Some Chinese banks phased out the use of the countercyclical factor in the pricing mechanism of the renminbi's central parity rate against the US dollar, according to a statement issued by the China Foreign Exchange Trade System on Oct 27.

The PBOC can take other prudential regulatory measures to maintain two-way balanced cross-border capital flows, Sheng said.

Financial institutions should focus on their core business to better serve the real economy, the part of the economy that produces goods and services, rather than betting on the renminbi's appreciation or depreciation, or even engaging in speculation, he said.

The PBOC issued a statement on Thursday, describing the two-way movement in the foreign exchange market as normal and urging market participants to avoid over-speculating on one direction.

The central bank stressed that China should hold fast to the managed floating mechanism that is driven by supply and demand with reference to a basket currency for a long time. Under such a regime, the exchange rate will not be used to stimulate exports (via depreciation) or tackle rising commodity price (via appreciation).

"We believe that the USD-RMB will be more two-way this year, as China's cyclical advantage narrows while the rest of the world catches up, with greater availability of vaccinations and economic re-openings," said Wang Jun, senior foreign exchange strategist with HSBC, in a report on Friday.