What the Surging Yuan Means for China’s Economy

The yuan’s surge this year is proving a double-edged sword, risking hurting the nation’s exports even while boosting the chances of currency and capital control reforms.

The exchange rate’s 5.7 percent advance this year has crushed depreciation pressures, allowing policy makers the freedom to loosen capital outflow controls that may impact the currency. The People’s Bank of China took a step in that direction on Sept. 11, scrapping a reserve requirement on the trading of foreign-exchange forwards that had made it expensive to short the yuan. Some of the potential lifting of curbs may help companies by making their overseas investment efforts easier.

Here’s a look at the implications of the yuan’s strength:

Export Risk

Overseas shipments are typically first in the firing line when a currency appreciates strongly, with official data showing a slowdown in China’s exports in the last two months as the yuan climbed 2.9 percent.

Profit margins may shrink unless the companies get payments in yuan, especially if they haven’t hedged enough, said Iris Pang, an economist at ING Groep NV in Hong Kong. She recommends increased hedging, adding that the yuan will become more volatile.

Any protracted yuan gains will make the authorities uncomfortable because exports are an important economic growth driver, according to MK Tang, senior China economist at Goldman Sachs Group Inc. in Hong Kong. Export growth has contributed to a 1 percentage point improvement in China’s gross domestic product this year, he added.

Capital Controls

The yuan’s strength gives the authorities an opportunity to ease capital curbs, some of which hurt China’s economy, said Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong. The potential steps include making it easier for companies to move money overseas and easing restrictions on foreign acquisitions by domestic firms. The nation toughened capital outflow controls last year in an effort to arrest depreciation pressures on the yuan, which plummeted 6.5 percent against the dollar in its biggest drop since 1994.

Wider Impact

The yuan’s strength has spread cheer to the nation’s equities market, with the benchmark Shanghai Composite Index extending a three-month advance to rise to the highest level since January 2016. Bonds have steadied as well after a three-quarter selloff as foreigners tripled their holdings of banks’ short-term debt and increased their ownership of sovereign bonds in August.

Reforms, Deleveraging

Chinese policy makers will likely take incremental steps to move the yuan closer to a free float, such as by allowing more two-way volatility and reducing intervention, said Goldman’s Tang.

A freer yuan will serve the nation’s economy well because resources will be allocated in a more efficient way without government controls, said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore. A steady currency market will also allow China more room to focus on its drive to reduce excessive borrowing, which will benefit the economy in the long term, he said.
Source: Bloomberg