There is a solid foundation for the RMB exchange rate to remain stable

In 2023, the global interest rate hike will ebb and flow, the financial market will be repriced by repeated emergencies, and the world's major currencies will go through a year of huge fluctuations.

Looking forward to 2024, as the mainland's various policy measures continue to play a role and the economic operation recovers, RMB assets will continue to be attractive, and the weakening trend of the US dollar index will increase favorable domestic and foreign factors, and the RMB exchange rate is expected to continue to rise.

Exchange rate flexibility is increasing

Looking back at the whole year of 2023, the central parity of the RMB against the US dollar has fallen by 1,181 basis points, or 1.7%, which is significantly narrower than the 9.23% decline in 2022, the onshore RMB has fallen by 1,406 basis points, or 2.02%, against the US dollar, and the offshore RMB has fallen by 2,038 basis points, or 2.9%, against the US dollar.

At the beginning of 2023, there was a brief recovery in the RMB exchange rate against the US dollar. In January 2023, affected by factors such as the weakening of the US dollar and the strengthening of economic expectations, the RMB regained the 6.7 mark and then fluctuated and fell, and then remained in the range of 6.8 to 6.9. However, with the strong rebound of the dollar index, which rose by 2.5% in just five months, the RMB showed a wave of significant decline, and the RMB exchange rate fell into the 7 range again, once bottoming out at 7.26.

Entering July 2023, as the Federal Reserve has become more and more vague about the policy of raising interest rates, and the economic recovery has accelerated after the implementation of a series of domestic policies, the RMB exchange rate has rebounded in a small wave. However, the rally failed to sustain. At the end of July, the Federal Reserve announced another 25 basis point interest rate hike and made a hawkish statement, hitting the market's interest rate cut predictions, the dollar index strengthened rapidly, and the RMB exchange rate fell again, and long-term sideways fluctuations around the 7.3 mark, the lowest touched 7.35. After November, the easing of external pressure and the recovery of the domestic economy pushed the RMB exchange rate to rebound significantly, recovering the 7.3 and 7.2 marks one after another, and breaking through the 7.1 mark intraday on December 14, of which the onshore RMB hit a maximum of 7.0955.

"On the whole, the fluctuation of the RMB exchange rate will increase in 2023, mainly due to the 'resonance' of the complex internal and external environment. Zhou Maohua, a macro researcher at the financial market department of Everbright Bank, believes that since the beginning of 2023, there have been fluctuations in the domestic macroeconomy, coupled with the uncertainty of the political and economic prospects of developed economies, and the volatility of the US dollar has intensified. However, from the perspective of the whole year, the RMB exchange rate remained stable as a whole, continuing to fluctuate in both directions around a reasonable equilibrium level, and the RMB exchange rate against a basket of currencies was basically flat.

As a matter of fact, the mainland's financial management departments have also stressed on many occasions that such two-way fluctuations in the renminbi exchange rate are a normal phenomenon. Previously, the People's Bank of China mentioned in the article "Deepening the Market-oriented Reform of the Exchange Rate" that the People's Bank of China has steadily deepened the market-oriented reform of the exchange rate, continuously improved the managed floating exchange rate system based on market supply and demand, adjusted with reference to a basket of currencies, the market-oriented level of the RMB exchange rate has been continuously improved, market supply and demand have played a decisive role in the formation of the exchange rate, the flexibility of the exchange rate has been continuously enhanced, two-way fluctuations have become the norm, and the RMB exchange rate has remained basically stable at a reasonable and balanced level. Practice has proved that this is an exchange rate system arrangement suited to China's national conditions, and has effectively played the function of an automatic stabilizer of the macroeconomy and the balance of payments.

Guan Tao, global chief economist of Bank of China Securities, said that the increase in the flexibility of the RMB exchange rate has improved the autonomy of interest rate regulation and control, and promoted macroeconomic stability, while the stability of economic fundamentals has supported the stability of the exchange rate, and the operation of the foreign exchange market has become more resilient, which is conducive to the formation of a positive interaction between interest rates and exchange rates.

Resolutely guard against the risk of exchange rate overshoot

Both the Central Financial Work Conference and the Central Economic Work Conference clearly emphasized the need to "maintain the basic stability of the RMB exchange rate at a reasonable and balanced level". It is worth noting that during the period of continuous weakening of the RMB exchange rate in the first half of 2023, neither verbal guidance nor actual actions have seen the regulator intervene.

In this regard, Zhang Jingjing's team of China Merchants Securities believes that the consensus expectation of the market on the depreciation of the RMB exchange rate in the early stage has not yet been formed, which is an important basis for the central bank to maintain policy determination. "Since 2018, the central bank's foreign exchange policy has focused on managing market consensus expectations, rather than specific points. In fact, the exchange rate of the renminbi against the US dollar has broken "7" several times in the past few years, but it has returned to below "7" in a short period of time. Therefore, "7" is no longer a psychological barrier, the overall economy is stable, and the people's expectations are stable.

Industry experts said that the slow recovery of the renminbi exchange rate against the US dollar is mainly caused by the "diametrically opposed" monetary policies of China and the United States, and the market is worried about future economic growth. With the Fed's interest rate cut expectations increasing and China's economy recovering, the RMB is likely to rise steadily in 2024.

"The interest rate differential between China and the United States is expected to gradually return to normalcy, and the valuation of RMB assets is low, which has strategic allocation value. In the face of increasingly complex global political and economic situations, RMB assets are expected to become a safe haven for global capital and provide investors with stable long-term returns. Zhou Maohua said.

If the regulator does not want to hold a specific point in the exchange rate in the first half of 2023, then in the second half of the year, "make a move when it is time to act" is not an empty phrase. On July 20, 2023, the People's Bank of China (PBoC) and the State Administration of Foreign Exchange (SAFE) decided to raise the macro-prudential adjustment parameters for cross-border financing of enterprises and financial institutions from 1.25 to 1.5 in order to stabilize the RMB exchange rate expectations. On August 22, the central bank tendered for the issuance of 35 billion yuan of central bank bills in Hong Kong, which is the fifth issuance of central bank bills in 2023 and the largest issuance. Since then, the central bank has continued to issue 15 billion yuan of six-month (182-day) central bank bills in Hong Kong on September 19, of which 5 billion yuan is a rolling renewal and 10 billion yuan is an additional issuance. This is the second time in a month that the PBOC has issued additional offshore central bills to raise the cost of shorting the RMB. On September 1, in order to improve the ability of financial institutions to use foreign exchange funds, the central bank decided to reduce the foreign exchange deposit reserve ratio of financial institutions by 2 percentage points from September 15, from the current 6% to 4%.

In Guan Tao's view, since the second half of 2023, the relevant parties have adopted a series of policy measures to stabilize the exchange rate, such as raising the macro-prudential adjustment parameters of cross-border financing, lowering the foreign exchange deposit reserve ratio of financial institutions, and issuing additional offshore central bills, and the cumulative effect has gradually emerged. "Especially since November 20, 2023, the fluctuation of the central parity of the RMB exchange rate has increased significantly every other day, changing the situation that the fluctuation of the RMB exchange rate has only been a few basis points since October, and the adjustment of dozens or even hundreds of basis points has further ignited the enthusiasm of the market to long RMB. Guan Tao said.

The regular meeting of the Monetary Policy Committee of the People's Bank of China recently held in the fourth quarter of 2023 also made it clear that deepening the market-oriented reform of the exchange rate, guiding enterprises and financial institutions to adhere to the concept of "risk neutrality", comprehensively implementing policies, correcting deviations, stabilizing expectations, resolutely correcting pro-cyclical behaviors, resolutely preventing the risk of exchange rate overshoot, preventing the formation of unilateral consistent expectations and self-reinforcement, and maintaining the basic stability of the RMB exchange rate at a reasonable and balanced level.

Renminbi assets remain attractive

With the emergence of the effect of macroeconomic policies, the economic fundamentals will be more solid, which is the largest basic for the stable operation of the exchange rate. The mainland adheres to the implementation of a normal monetary policy, with sufficient policy space and a rich toolbox. At the same time, the trend of RMB is clear, RMB assets are safe, and the recognition of RMB in the world will continue to increase in the future. In addition, the RMB exchange rate formation mechanism is suitable for China's national conditions, can give full play to the role of the market and the government, and has withstood the test of multiple rounds of external shocks.

The key to stabilizing the exchange rate is still to stabilize the economy. In the process of resuming the economic development in waves and zigzag forward, stabilizing the exchange rate cannot replace the necessary policy stimulus and structural adjustment, but is more about buying time for economic adjustment. Industry experts believe that despite the disruption of international policy factors and market behavior in the future, the relative changes in economic growth, price changes and balance of payments between China and the United States will still promote the continued appreciation of the RMB exchange rate.

First of all, from the perspective of external factors, since December 2023, many central banks around the world have chosen to pause the pace of interest rate hikes, and the market focus has further shifted to the timing of interest rate cuts. In 2024, the risk of a slowdown in the U.S. economy will increase, inflation expectations will cool, and a presidential election will be held, and the Fed may most likely end the interest rate hike cycle and turn to interest rate cuts. In this context, the U.S. dollar index may continue to fall, the interest rate gap between China and the United States will continue to narrow, and the external pressure on the RMB exchange rate will be eased.

Secondly, from the perspective of internal factors, the "troika" in 2024 will synergistically promote the economic growth of the mainland to varying degrees. If the policy continues to promote and demand continues to release, consumption will still become the primary driving force for economic growth. Infrastructure investment and manufacturing investment are still the two major levers for stabilizing investment and growth, while real estate investment has weakened the drag on investment driven by favorable policies and economic recovery.

At the same time, with the downturn in world economic growth, mainland exports are likely to remain under pressure, but resilience remains. With the support of proactive fiscal policy and prudent monetary policy, the lack of market demand in the mainland will improve in 2024, and GDP is also expected to show a slight growth.

Finally, the current mainland has abundant policy tools for exchange rate control, and the scale of foreign exchange reserves continues to rank first in the world, which will also support the stability of the RMB exchange rate.

The data shows that with the recent strengthening of the RMB exchange rate, the net inflow of foreign capital under securities investment has generally resumed. According to a report by China Galaxy Securities, in November 2023, the deficit in capital and financial accounts narrowed sharply by US$17.7 billion month-on-month. Portfolio investment ended a four-month deficit and turned into a surplus of $13 billion. In November, foreign investors increased their net holdings of domestic bonds to US$33 billion, the second highest in history. Foreign capital inflows under Bond Connect have been net for three consecutive months, of which foreign institutions mainly increased their holdings of government bonds by RMB112.8 billion, interbank certificates of deposit by RMB86.7 billion, and policy bank bonds by RMB49.4 billion in November. (Reporter Yao Jin)

Source: Economic Daily