The Chinese renminbi has fluctuated widely this year, both against the dollar and its trade-weighted basket, and is on balance substantially down despite its recent uptick. Yet China’s current account surplus – in the order of 2% of gross domestic product – is quite large and its trade surplus burgeoning, which would normally buoy the currency. This has led some analysts to ask whether China might be seeking a lower renminbi to support external demand.
Stepped-up capital outflow has been a key driver of the lower renminbi, largely in view of higher US rates. A peak in US interest rates and China ‘reopening’ could well dampen such outflows. But avenues for capital outflow remain significant. On balance, the authorities have acted this year to slow renminbi depreciation against the dollar and seem comfortable with appreciation at the current time.
The renminbi was net flat this year on a trade-weighted basis through mid-October but has fallen roughly 4.5% since then (Figure 1).
Figure 1. Renminbi’s trade-weighted basket falls
The renminbi is down nearly 8.5% versus the dollar this year but has risen 5% from its October lows. In contrast, the euro is down 7% overall this year against the dollar but up roughly 10% since its late-September lows. The yen is down 15% overall.
The renminbi is managed, even if significantly greater flexibility has been achieved in recent years and the authorities have stepped back from the foreign exchange market. Chinese authorities often emphasise that they seek renminbi stability on a trade-weighted basis. But the authorities appear to keep one eye on the trade-weighted currency, which relates importantly to current account flows, but also on the renminbi/dollar exchange rate, which is consequential for capital account flows.
China retains significant capital controls. The authorities have many management tools at their disposal beyond central bank intervention (which the authorities have been wary of using in past years). For example, this year they have used the daily fixing to send messages to the market about the need to slow renminbi depreciation, jawboned extensively in public, altered reserve requirements on foreign deposits and offered administrative guidance to the large state-owned commercial banks dominating FX trading. They appear at times to allow these banks to stealth intervene.
On its face, given the large current account surplus, capital controls and the authorities’ influence over the FX market, analysts might reason that capital outflows could not overwhelm the current account and drive the renminbi lower.
However, China’s experience in 2015-16 casts doubt on that argument. Prior to 2014, China generally experienced twin surpluses – on the current and capital account. But in 2015-16, China experienced massive ‘other’ outflows and errors and omissions, swamping the current account surplus. The renminbi faced a continuous seemingly self-reinforcing wave of heavy downward pressures, partially countered by a $1tn reduction in the People’s Bank of China’s reserves.
Figure 2. China’s current and capital account data as share of GDP
|Current account surplus/GDP||1.5||2.2||2.7||1.7||1.5||0.2|
|Errors and omissions||-0.7||-0.6||-1.9||-1.7||-1.7||-1.3|
|Renminbi up (+) or down (-) vs $ end of play picture||+2.6||-2.1||-4.5||-6.7||+6.9||-5.4|
Source: International Monetary Fund Article IV reports, table 3, China: balance of payments
Analysts at the time attributed the sharp turn to capital outflow to a range of factors: corporations no longer seeing renminbi appreciation as a one-way bet; changes in firms’ leads and lags practices; outflows associated with some capital account liberalisation and desired portfolio internationalisation; household sector capital flight; and the authorities’ missteps in communicating with markets, including the August 2015 devaluation.
Net equity inflows into China have been impacted by this year’s economic woes and Russia’s barbaric invasion of Ukraine. China’s stock market is substantially down this year, by some 12%. China’s State Administration for Foreign Exchange 2022 third quarter balance of payments data showed a pick up in third-quarter financial account outflows – including net errors and omissions.
In short, it is not likely that China has been seeking a lower renminbi to boost external demand to compensate for the economic slowdown. Given a slowing global economy, it is not clear that exports could be relied upon in any case. Even though China retains considerable tools at its disposal to counter renminbi depreciation pressures, the avenues for capital leakage available to investors allow for large scale outflows.
Recent easing in US rates coupled with signs of some Chinese reopening make a reoccurrence of even a smaller 2015-16 scenario highly unlikely. But given the overall narrowing this year in interest differentials to the detriment of Chinese assets, the unpredictability of Chinese lockdowns, housing woes, economic weakness and recent uncertainties, the potential for further future significant capital outflow cannot be minimised.
Mind the Chinese capital account.
Mark Sobel is US Chair of OMFIF.