The yuan exchange rate: Short-term fall, long-term pull
Bruce Pang

Editor's note: Bruce Pang is the chief economist and head of research at JLL Greater China. The article reflects the author's opinions and not necessarily the views of CGTN.

Prior to the market's opening on Monday, the People's Bank of China (PBOC) set the yuan off a 16-year low against the U.S. Dollar (USD). The PBOC anchored a daily midpoint guidance rate at 7.2148 per USD, over 1,280 pips firmer than market estimate, and the largest deviation on record.

The wider fixing gap implies that the authorities are again showing determination to prevent the yuan from further weakening, with a policy gesture to guide market expectations toward less depreciation.

The major reason behind yuan's recent weakness was mainly a passive depreciation on the back of a stronger dollar. As the U.S. is still facing persistent inflation pressure and higher odds of a soft landing for its economy, the Federal Reserve is likely to continue maintaining interest rates at high levels for some time to come. Meanwhile, macro-outlook of major European economies remains challenging and uncertainty remains elevated, leading to a firmer USD as risk aversion has ran wild on the street.

All these factors have boosted the USD Index to move higher in the near term, bringing short-term pressure on the yuan exchange rate against the USD. However, the yuan stayed strong against other major currencies, as the China Foreign Exchange Trade System (CFETS) RMB Index, a currency basket including more than ten major currencies, was on the rise since mid-July.

The yuan could see challenges ahead in the near term, given the uncertainties of the Fed's pace, the policy split between China and the U.S., and the souring global risk appetite. However, the strength of the greenback will only be transient. More importantly, the central bank's move today, together with other recent policy signals, will allay fears of the yuan continuing to slide, helping to stabilize market expectations and keeping the yuan exchange rate at an appropriate and balanced level.

For the past few months, authorities have introduced a flurry of measures to limit further decline of the yuan – setting firmer-than-expected daily guidance rates, lowering the foreign exchange reserve requirement ratio (RRR) for banks, issuing more central bank notes in Hong Kong SAR, etc. The foreign currency liquidity in the banking system is being fine-tuned, and the market sentiment improved. There is also still sufficient room for trade-offs and maneuver in the policy toolkit.

From a longer-term perspective, the yuan exchange rate is supported by solid economic fundamentals in the mid- to long-term, on the back of China's moderate stimulus, reasonable easing, counter-cyclical measures, pragmatic growth strategies, and resilient growth momentum. It would be fair to say that China still has the foundation, capacity, confidence, ability as well as means to keep the yuan basically stable at reasonable, balanced levels. Two-way fluctuations around these levels are expected, while unilateral depreciation of the yuan will not be seen, and the market's decisive role in yuan exchange rate will remain unchanged.

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