Chinese Yuan should be allowed to depreciate, says state newspaper6 August, 2012, 18:28. Posted by Zarathustra
China Securities Journal, a state newspaper, publishes a comment today which suggests that perhaps China allow Chinese Yuan (or renminbi) to depreciate in hope to stimulate the economy.
The comment suggests that because of the on-going euro mess, and strength of the US dollar as well as the sharp slowdown of the Chinese economy, the expectation for Chinese Yuan depreciation has been accepted by the market. Although depreciation may risk capital outflow, the comment suggests that depreciation could relieve the pressure on monetary policy easing by supporting exports.
We hardly believe that allowing Chinese Yuan to depreciate would be tremendously helpful for the economy as the comment suggested, although we have been expecting depreciation since last year as the pace of slowdown gather pace. The chart below shows that Chinese Yuan has been depreciating against the US dollar since the beginning of this year, although because of the weakness in the Euro, Chinese Yuan has actually been appreciating against the Euro.
Although the comment views the risk of capital flow as a risk that is worth taking, we would like to stress once more that capital outflow for China is associated with tighter monetary condition as the central bank is slowly selling off foreign assets to buy Chinese Yuan, and the admission that the authorities are now willing to let the currency depreciates will only increase outflow, thus tighten monetary condition even further should the central bank “defend” the exchange rate.
In the past, the foreign exchange intervention has been performed by creating more money to curb appreciation of Chinese Yuan. More recently, the intervention has been to buy up Chinese Yuan to prevent it from falling too fast, or in a more dramatic language, to “defend” the exchange rate (see a few charts on this here). This is consistent with the first balance of payments deficit since 1998 as well as some higher frequency estimates of capital flow, suggesting that the monetary authorities are tightening monetary condition in order to stabilise exchange rate.
Of course, it is currently not a huge issue for China as the capital outflow remains small compared to its reserve, and no one is predicting an imminent collapse of Chinese currency. But it has to be understood that this limit the ability for the central bank to use monetary policy tools to stimulate economy.