The financial landscape in China has been witnessing significant fluctuations, particularly concerning the value of the Renminbi (RMB) in relation to the US dollarSince the latter part of last year, the off-shore RMB has experienced a downward trend, notably breaching critical thresholds such as the 7.3 mark against the dollarThis decline has sparked concerns over the risk of currency devaluation, a phenomenon that can ripple through both domestic and international economic frameworks.

In response to the depreciation pressures, the People's Bank of China (PBOC) has embarked on measures aimed at stabilizing the RMB's exchange rateThese interventions have included adjusting the reference rate for the RMB and tightening liquidity in the off-shore marketsThe PBOC's actions reflect a concerted effort to convey a strong commitment towards maintaining a stable exchange rate, with officials reiterating the importance of a stable currency in fostering economic confidence.

The quarterly meeting held on January 3 saw a noticeable shift in the PBOC’s rhetoric, signaling a more assertive stance regarding exchange rate stability

Following this, on January 9, the central bank made a landmark announcement concerning the issuance of 600 billion yuan of central bank bills in Hong KongThis move aims to increase the supply of high-quality RMB-denominated bonds in the offshore market, potentially bolstering confidence in the currency.

Subsequent developments included a slight adjustment in the RMB’s central parity against the dollar, falling by five points to 7.1891 on January 10. Despite this dip, the central bank has managed to keep fluctuations in the actual spot exchange rate relatively contained, which may indicate a cautious approach to managing market expectations.

Understanding the PBOC’s current policy logic requires an examination of the broader economic contextAnalysts from Xibu Securities noted that the depreciation of the RMB has limited positive effects on China's balance of payments

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With inflation rates domestically trailing behind those in the US and other developed economies, the relationship between nominal and real exchange rates becomes increasingly complexEven with nominal rates remaining stable, the actual exchange rate can still weaken due to local price movements, leading to a decline in purchasing power.

Forecasts suggest that, in the intermediate term, the stability of the RMB will hinge on both domestic and international factorsWhile external conditions—such as the strengthening dollar—are largely beyond China's control, there are levers within the domestic economy that Beijing can adjustSpecifically, increasing fiscal policy measures aimed at stimulating domestic demand and enhancing price levels could potentially elevate returns on RMB assets, thereby providing some support to the currency.

So what has contributed to the recent weakness of the RMB? The decline can be traced back to the end of September last year, against the backdrop of a rising dollar coupled with weakening domestic economic indicators and reducing trade surplus

A notable appreciation of the dollar has exerted downward pressure on the RMB, instigating fears among market participants.

From November onward, indicators such as slowing retail sales growth and a contracting Purchasing Managers' Index (PMI) have further dented market confidenceAdditionally, the banking sector has seen a reversal in the surplus of foreign currency settlements, leading to an unprecedented monthly deficit due to falling bond yields and stock market declinesSuch patterns generally do not favor a stable currency, hence the increased urgency for PBOC interventions.

The concept of the "stable exchange rate" is pivotal for any economy, serving as a mechanism for regulating international balances through the current accountHowever, Xibu Securities emphasizes that China's challenges stem not from external trade deficits but from outflows in the financial accountThis outflow suggests that the RMB is not fundamentally overvalued, raising questions about the effectiveness of mere devaluation as a remedy.

The broader implications of a weaker RMB on international balances are fraught with uncertainty

While depreciation might superficially improve the current account, it could also heighten the risk of trade conflictsA sharp drop in the value of the currency may incentivize capital outflows, thereby creating a contradictory dynamic where the efforts to support the RMB could paradoxically lead to escalating market concerns.

Throughout 2024’s initial three quarters, China's current account surplus relative to GDP has hovered at 1.8%, while non-reserve financial accounts reflected a deficit rate of 2.3% relative to GDPThe increasing prevalence of global trade tensions places additional pressure on China, the world's largest exporter, to weigh the implications of economic policy both domestically and in relation to international trade dynamics.

The report also sheds light on the inflation landscape, highlighting that China’s price growth remains subdued compared to international counterparts

This discrepancy in inflation rates plays a critical role; in a context where nominal exchange rates are stagnant, real rates consequently declineSince 2021, the actual exchange rate of the RMB against the dollar has depreciated by 22%, a substantial contrast to the nominal drop of just 8.8%, illuminating the stark reality of eroding purchasing power and competitiveness.

Given the current scenario, one question looms large: Can the RMB stabilize? In the short term, analysts suggest that the central bank possesses an ample reserve of foreign currency assets to sustain stability in the exchange rateWith the largest stockpile of reserves globally, and foreign debt levels maintaining a steady ratio to GDP—around 14% as of the third quarter of 2024—China appears well-positioned to cushion potential shocks.

However, longer-term stability remains tied to domestic fiscal policy alignment and international market conditions