Yuan is weighed down by monetary divergence – but supported by the current account

By Siwat Nakmai

Charting the factors that influence the yuan/dollar exchange rate.

What governs the value of China’s renminbi? There are several factors that push and pull on the USDCNY exchange rate.

Central bank policies

Our first chart tracks the effect of the differing monetary policies of the Federal Reserve and its Chinese equivalent over the past 15 years. The top pane charts the exchange rate – in blue – against the yield differentials between 10-year benchmark US and Chinese government debts (in green). These have broadly tended to track each other; as US yields have widened the gap with their Chinese equivalents, the yuan has depreciated; a dollar is worth about 7.3 yuan, near a 15-year high.

The second pane of our chart tracks the central banks’ key benchmarks; the sharp monetary tightening by the Fed contrasts with the gradual loosening by Chinese policymakers. Given the possibility of disinflation or deflation in China and persistent inflation in the US, it is conceivable that PBoC rates may be lower while Fed rates remain high for a longer period. This trend could continue, which would put downward pressure on the CNY.

Persistent surpluses

Our next chart addresses China’s current account, especially goods and travel trade balances.. Historically, China’s persistent current-account and goods trade surpluses help support the value of the currency, but these trends are facing headwinds.

As the middle pane shows, exporters have been struggling due to a global slowdown. Exports have been falling year-over-year (the blue bars, measured on the left-hand axis) and PMI, a measure of economic sentiment, computed based on China’s exports is in negative territory (below 50 on the right-hand axis and measured by the orange line).

The bottom pane uses Chinese international flights as a proxy for inbound tourism, and arrivals in Hong Kong from mainland China as a proxy for outbound tourism. Both look to have a similar distance below pre-pandemic norms. This suggests that the tourism trade balance and the current account’s services deficit, which typically under-weighs goods trade surpluses, could be comparable to the previous normalcy.

Accordingly, the current account could stay positive amid challenges.

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