No basis for substantial yuan depreciation

BEIJING - Despite short-term volatility, the yuan will remain stable as various factors underpin resilience in the currency in the long term.

The yuan has continued to strengthen, shrugging off worries over the health of the economy with the government softening the 2016 GDP target and rating agency Moody's downgrading China's sovereign bonds. Policy makers at the ongoing annual sessions of legislators and political advisors have endeavored to reassure investors that the yuan will be held stable against a basket of currencies.

Some weakening in the short term is understandable, as China's forex controls are loosened to give the market greater sway. With the Fed shutting off its money spigot, emerging economies are feeling the effects of capital outflows, and the yuan cannot be expected to be totally immune to dollar strength.

However, fundamentals remain sound. China's trade surplus is more than adequate. There are ample foreign exchange reserves, little foreign debt and clear determination on the part of the government to revitalize the economy.

As a clear manifestation of confidence in the currency and another milestone on the road to full internationalization, from October the IMF will include the yuan in its SDR basket.

China's economy may be expanding more slowly than it has for 25 years, but the current level of growth is still the envy of the world and domestic finances are in better shape than most, developed or emerging. These factors, combined with China's political stability leaves the economy set fair to face global headwinds.

With global commodity prices weak, the account surplus of the world's biggest commodity consumer seems destined to increase, offsetting any capital outflow or depletion of FX reserves. According to an estimate by Kenneth Courtis, former Asia vice chairman of Goldman Sachs, low crude prices alone could reduce China's energy costs by $320 billion this year, with a total saving across the board of as much as 460 billion dollars.

What is more, the Chinese government neither wants to see substantial declines in the yuan nor has any intention of boosting exports through devaluation. As China officially joined the European Bank for Reconstruction and Development in January, Premier Li Keqiang told bank President Suma Chakrabarti that, "China has no intention of stimulating exports via competitive devaluation."

Depreciation is not without its appeal. All else being equal, Chinese exporters would regain some of their lost competitiveness, and by raising the cost of imports, it would help stave off deflation. These benefits may well be outweighed by the possibility of igniting a currency war that would wipe out any possible advantage. Depreciation might also hurt the economy in other ways, driving capital outflows and subjecting domestic importers to unnecessary risks.

Worst of all, depreciation could put sand in the wheels of China's Herculean effort to replace a worn-out growth model based on trade, investment and heavy industry with sustainable expansion driven by consumer spending and entrepreneurship.

With devaluation ruled out as a quick fix, the chosen remedy is a long-range plan to cut industrial overcapacity, eliminate excess inventories and reduce costs for businesses, while nurturing new enterprises, with new ideas, products and methods.

With all these economic factors in place, the yuan may even appreciate slightly, although, given growing downward pressure and the central bank's bias toward easing, a sharp strengthening is unlikely.