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CF40 Youth Forum on RMB exchange rate against China-US policy divergence

On January 6, 2022, China Finance 40 Forum (CF40) held a Youth Forum themed “Cross-border capital flow and RMB exchange rate against China-US cyclical divergence”.

The US dollar (USD) has been pretty strong recently. At the same time, the value of Renminbi (RMB) has also been on a continuous upward ride. Minutes from the FMOC’s December meeting indicated that the Fed was ready to aggressively dial back its policy support, partly by signaling three rate hikes in 2022, the first one immediately followed by a taper. This raises the possibility of policy divergence between China and the United States. What impacts will this have on China’s cross-border capital flow and RMB exchange rate? How will the value of RMB evolve going forward? Will China face greater capital outflow pressure?

The event brought together a group of leading financial practitioners, scholars and policymakers in China to dive into these issues.

According to the experts, the rare simultaneous rise in the value of RMB and USD was attributed to several structural factors: the big surplus that China has recorded both with exports and with foreign exchange was the main reason; China has also registered net capital inflow under its direct investment and securities investment accounts which further boosted its currency’s performance; and the brightening prospect as a result of eased tensions between China and the US has indirectly lifted RMB as well. In addition, experts noted that RMB is presenting increasing arbitrage opportunities, with its relative steadiness and considerable spreads.

There is no sufficient evidence to suggest one-way movement of RMB’s exchange rate, experts pointed out, and further elaborated from two angles: the pace of foreign exchange transactions of exporters and importers, and the level of fluctuations in the exchange rate. Whenever there is such expectation, whether of appreciation or depreciation, exporters would step up, while importers would slow down; their transactions and the exchange rate would usually appear more volatile. But neither has happened in China, showing that market expectations remain steady at the moment. Experts believed that the current exchange rate is fairly reflecting the actual supply-demand relation, without significantly deviating from its fair value or facing any major overshooting risk.

However, the surplus that has been supporting a strong RMB and massive capital inflows into China is now fading, participants at the Forum warned, cautioning against risks in the short term of a weakened yuan and greater capital outflow. The downward pressure on RMB exchange rate is mainly ascribed by the experts to the country’s slackening exports, the narrowing spreads between RMB and the strong USD, and the policy divergence between China and the US, if not the rest of the world at large.

Despite the strains, experts had faith that the depreciation of RMB and capital outflow risks going forward would be limited because of the large surplus receivables of foreign exchange traders with unsettled transactions, the restricted impact of the rate spread between China and the US, and a higher global demand for diversified asset allocation.

The event wrapped up with policy suggestions from the experts, which came down to three major points: first, macroeconomic regulation and control in China must focus on improving the economy’s fundamentals and boosting market confidence; second, there is a need to further increase the flexibility of RMB’s exchange rate regime to avoid expectation of one-way exchange rate movement; and third, China should keep pressing ahead with institutional reforms including the capital account reform, and give the market a bigger role in shaping the currency’s value.