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Vital to keep yuan stable after US Fed rate cut

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The reduction in China’s current account surplus, and a possible current account deficit this year, may have a negative impact on the yuan’s exchange rate. AFP

Vital to keep yuan stable after US Fed rate cut

In the wake of the World Health Organisation declaring the novel coronavirus outbreak a pandemic on March 11, the US Federal Reserve, in its most dramatic move since the 2008 global financial crisis, cut its benchmark interest rate to near zero.

While the central banks of several countries, including Canada and Britain, followed the Fed to cut their interest rates, the central banks of economies with no room for rate cuts as they already have negative interest rates, such as Japan and the EU, decided to expand credit support or asset purchase.

Which suggest that, to cope with the impact of the coronavirus outbreak on economies and the global financial market, major central banks may adopt loose monetary policy sooner or later.

Given that the spread of coronavirus is yet to be effectively curbed outside China even after almost two months, its negative impact on the world economy could be huge. Also, if the global financial market declines sharply, major central banks including the Fed are expected to launch a new round of loose monetary policy, in order to stabilise market expectations and arrest the economic decline.

However, despite the increasing possibility of further loosening of monetary policy across the world to overcome the impact of the outbreak, the yuan is expected to remain stable, even rise slightly against the US dollar.

First, since China has largely contained the outbreak within the country-while many countries continue to fight the virus by taking stringent measures-the country is relatively well placed to resume normal production soon.

Second, although the People’s Bank of China, the country’s central bank, has also cut the interest rate to increase liquidity, its loose monetary policy is moderate compared with those of EU and US central banks. The interest rate spread of China and the US’ national debt reflect the difference in the two countries’ loose monetary policy. For example, the 10-year return rate on Chinese government bonds is to 2.6 per cent, while in the US it is only 0.8 per cent.

And third, international financial capital is currently inclined to flow into China. Even at the height of the novel coronavirus outbreak in China, foreign financial institutions increased their investment in the country’s bond market.

By the end of February, for instance, foreign institutions held Chinese bonds worth 2.28 trillion yuan ($321.16 billion), up 90.2 billion yuan from the end of 2019. The trend of foreign capital flowing into the Chinese market is likely to continue as Chinese enterprises gradually resume production now that the outbreak has been largely contained in the country.

These factors are conducive to the yuan remaining stable, even slightly rise against the dollar.

But the reduction in China’s current account surplus, and a possible current account deficit this year, may have a negative impact on the yuan’s exchange rate. Data released by the National Bureau of Statistics in March show China’s total import and export value in the first two months of the year was about $592 billion in US dollar terms, a decline of 11 per cent year-on-year. While exports declined 17.2 per cent to about $292 billion, imports fell four per cent to about $300 billion. In real terms, the trade deficit was $7.09 billion in the first two months of this year, compared with a trade surplus of $41.5 billion in the corresponding period last year.

Because of the novel coronavirus pandemic, EU and US imports from China could further decline. As the “world’s factory”, China could also face more problems than any other economy if the global industrial chain suffers a major disruption. And the fact that China has to expand purchase of US commodities according to the recently signed “phase one” Sino-US trade deal will make it difficult for China to maintain a high current account surplus as in the past.

And since the high current account surplus has been a major reason for the yuan’s stability against the US dollar, the impact of a current account deficit on the yuan’s exchange rate cannot be ignored.

Financial markets across the world are experiencing a slump due to the pandemic, yet the yuan has been relatively stable. And to ensure the Chinese currency remains stable, the authorities should take measures to minimise the chances of the yuan fluctuating wildly, especially in offshore trading, against the dollar amid the rapidly changing global financial market. CHINA DAILY/ASIA NEWS NETWORK

Ding Meng is a senior analyst with the Bank of China, Macao branch. The views do not necessarily reflect those of China Daily.

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