The recent continued sharp depreciation of the RMB against the USD has become a highly concerning and worrisome situation for the market.
The offshore RMB exchange rate in the Hong Kong market, for example, was 6.3768 per USD on April 18. On April 23, it rose to 6.5247 per USD, reaching an intraday high of 6.5469 per USD. The RMB has depreciated by 1,479 basis points, or 2.3%, in a week. By April 23, the RMB dropped to near its lowest level since April 2021, erasing all of its appreciation over the past year. As seen in the steep depreciation trend of the RMB exchange rate, the RMB depreciated very rapidly last week, indicating a significant change in the market’s perception of the RMB.
Figure: The RMB’s recent significant depreciation against the USD
The sharp depreciation of the RMB has been accompanied by sharp falls in Chinese stocks. As of April 22, the SSE Composite Index was down 15% since the beginning of the year (down 4.4% last week) and the SZSE Component Index was down 25.3% (down 5.5% last week). While stock indices have fallen, foreign capital has begun to withdraw from the domestic stock market. Foreign investors have sold a net USD 1.01 billion worth of Chinese stocks through the Hong Kong-China Stock Connect program since April, after selling USD 7.1 billion in March, according to Refinitiv Eikon. Schroders indicates that the Chinese stock market valuations are now back to the troughs observed in March 2020 when the COVID-19 pandemic began, and December 2018 when U.S.-China tensions intensified.
China’s bond market has also started to see outflows of foreign capital. Chinabond’s data reveal that net foreign capital outflows in the domestic bond market reached nearly RMB 80 billion in February and RMB 110 billion in March. According to the State Administration of Foreign Exchange (SAFE), net foreign capital outflows under bonds and equities fell by 39% and 44%, respectively, in late March compared with mid-March. Foreign capital outflows have been able to be moderate since April, and net inflows were recorded on some trading days.
On the whole, with the depreciation of the RMB exchange rate, the stock market and bond market have seen a net outflow of capital. It is clear that both domestic and international capital are re-evaluating the Chinese market, and risk expectations for the Chinese capital market are rising.
In the face of this unfavorable situation, on the afternoon of April 22, Wang Chunying, SAFE deputy director and spokesperson, came forward and gave the explanation on this. Wang said that China’s foreign exchange market was generally stable, and it was mainly reflected in the stable RMB exchange rate, the overall stability of cross-border capital flows, and stable foreign exchange market expectations. On the issue of the RMB exchange rate, Wang said that since this year, as of April 21, the U.S. dollar index has risen by 4.2%, while the EUR, GBP, and JPY have depreciated against the USD by 4% to 10%. Although the RMB has slightly depreciated against the USD, it still appreciated against a number of currencies, thus showing that the overall exchange rate was still stable.
Generally speaking, stabilizing market expectations is one of the important responsibilities of a country’s foreign exchange management department. From a market perspective, however, it may be more important to make objective judgments about trends in the RMB exchange rate and capital market flows.
From the institutional perspective, there are several reasons for the depreciation of the RMB exchange rate. CITIC Securities believes that the recent increase in pressure on RMB exchange rate depreciation mainly comes from two factors, i.e. the downward pressure on economic fundamentals due to the pandemic and the strengthening of the USD. Supply chain disruption combined with an uptick in the U.S. dollar index could weigh on the RMB in the near term, but this is insufficient to lead to depreciation expectations. BOC International believes that it is widely expected that the Federal Reserve will have more aggressive interest rate hikes and even start shrinking its balance sheet at the same time, which will inevitably cause turbulence in the U.S. economic and financial markets and increase two-way fluctuations of the RMB exchange rate. In spite of this, devaluation fears are unlikely. Soochow Securities believes that the RMB depreciation pressure in the second quarter is relatively large; the recent sharp fluctuations are not normal and are probably related to the current poor situation of China’s economy and foreign trade. Soochow Securities analysis believes that in the case of shrinking foreign trade, the volume of foreign exchange purchases by banks on behalf of their customers has increased significantly, leading to sharp fluctuations in the market. This, in turn, can result in the situation of “depreciation-deleveraging-depreciation”.
Researchers at ANBOUND believe that there are two main factors that may be under-considered in the current analysis of the sharp depreciation of the RMB, i.e. the impact of international geopolitical turmoil. and the increased downward pressure on the domestic economy related to the COVID-19 pandemic. We believe that, unlike in the past, the current main factors affecting the RMB exchange rate are not those of a technical nature, such as changes in corporate demand for foreign exchange settlement and sales, changes in foreign trade, changes in capital flows caused by China and the U.S. monetary policies, let alone the signing of currency swap agreements between countries. ANBOUND is of the opinion that geopolitical turmoil and downward pressure on the Chinese economy are becoming the main factors influencing the RMB exchange rate. Compared to them, all other factors are of secondary importance.
“Geopolitics is resetting our world, rendering everything else insignificant”, Chan Kung, founder of ANBOUND, wrote in the article “Bracing the Era of Economic Shortage”. According to Chan, in today’s world, the cause of economic distress and potential major crisis is not the source of crisis that Karl Marx predicted, i.e. capital, but the most important driving factor is geopolitics, which dominates the reset process of the world economy. The conflicts in today’s world are mostly caused by civilizational differences, ideological diversities, and political ambitions.
Which countries and regions will benefit from a world of geopolitical turmoil? The answer, according to Chan, is the relative re-emergence of the Anglo-American axis, the maritime nations, and the American continent. From the perspective of the spatial pattern of the world, conflicts and competition are in the continental regions, while the maritime nations represented by the Anglo-American axis have more prominent opportunities for development and prosperity than ever before.
Geopolitics will have an important impact on global currencies. In recent years, the view of the declining status of the USD has become a consensus in the market. The proportion of the USD in international trade settlement is decreasing, while the proportion of the EUR is increasing. There are also a lot of discussions about the possibility of the RMB entering the international market and gaining a larger market share in the future. In the wake of the war in Ukraine, there was also a prevailing view that tough U.S. and European sanctions to kick Russia out of the SWIFT system would lead to further fragmentation of international currency markets by raising fears about the use of the USD. Yet speculation about currency diversification is worthless in the face of geopolitical shocks. With the ongoing war in Ukraine, the USD’s international status is likely to be greatly strengthened, instead of being weakened. To put it bluntly, no other currency in the international market is a currency except the USD, because there is little room for other currencies to trade and they are more akin to “IOUs”. Geopolitical factors will allow the USD to maintain a long-term advantage over the RMB, which is the long-term basis of the exchange rate between the RMB and the USD.
The downward pressure on the Chinese economy under the pandemic is another important factor for the market to evaluate the Chinese market. Generally speaking, when there is international geopolitical turmoil, especially after the outbreak of war in Ukraine, investors tend to seek safe and stable markets in big countries. In addition, China’s COVID-19 control measures over the past two years have ensured its manufacturing and export capacity, forming a comparative advantage as “the world’s factory”. However, the global pandemic situation has changed in 2022. As the international community gradually adapts to the omicron variant, which is more contagious but has a lower fatality rate, the global economy shows an overall recovery trend. China, on the other hand, is in a different situation.
Since March, there have been multiple COVID-19 outbreaks in China. Although the variant and the characteristics of the coronavirus have changed, China still adheres to the strict preventive and control policies that it adopted previously. In the past two months, its transportation, logistics, production, consumption, trade, and other economic activities have been artificially disrupted on a large scale, which has greatly affected the economy. The country’s economy grew only 4.8% in the first quarter from a year earlier, with Guangdong and Shanghai, two pillars of the economy, growing at a sluggish 3.3% and 3.1%, respectively. How long will this policy last? If the spread of the COVID-19 cannot be contained, will China continue to adopt similar practices? The market is highly skeptical of this. Market concerns will be reflected in various aspects such as investment strategy choices, capital flows, the rise and fall of exchange rates, and so on. If the Chinese economy does not emerge from the downward pressure, and if capital expectations for the Chinese market turn sour, this is bound to be reflected in the RMB exchange rate accordingly.
Final analysis conclusion:
The recent sharp depreciation of the RMB against the USD is not necessarily a market-determined “normal two-way fluctuation”. Geopolitical factors and China’s economic downturn under the impact of the pandemic will be the two main factors determining the basic trend of the RMB exchange rate in the future. In this regard, the depreciation of the RMB will be the major trend in the future.
Writer by He Jun
Partner, Director of China Macro-Economic Research Team and Senior Researcher. His research field covers China’s macro-economy, energy industry and public policy.
For more information:
Website: http://www.anbound.my
Twitter: https://twitter.com/ANBOUND1993
LinkedIn: https://www.linkedin.com/company/anbound
Facebook: https://www.facebook.com/AnboundResearchCentre
Instagram: https://www.instagram.com/anboundthinktank/
Medium: https://anboundkl.medium.com
