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Will China Continue to Prop Up Dollar

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China's yuan to continue rise against US dollar in short term, but when will Beijing say enough?

China's yuan is expected to continue appreciating against the US dollar in the early part of next year due to strong growth of the Chinese economy and weakness in the American currency due to a coronavirus-induced slowdown in the United States, analysts said.

However, they disagree over whether the yuan will continue appreciating throughout the entire year, with some arguing Beijing will step in to stop an excessive rise that would endanger the economy and its policy priority to promote home-grown innovation.

The Chinese currency has strengthened since June alongside the country's rapid economic recovery from the damage caused by the coronavirus pandemic and on Monday improved to 6.5361 against the US dollar, according to the China Foreign Exchange Trade System.

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Liu Ligang, chief China economist at Citigroup, made the boldest assessment, predicting the yuan would strengthen by 10 per cent to 6 per dollar, or even more, by the end of 2021.

The lower the figure in the US dollar-yuan exchange rate, the stronger the Chinese currency, since it means it takes fewer yuan to purchase one dollar.

"The problem China faces next year will be huge, unrelenting capital inflow. The yuan appreciation will be a key threat to China's macro economy," Liu said in an interview with Bloomberg.

As the US Federal Reserve, the European Central Bank and other major central banks continue to pump large amounts of money into their financial systems to support growth and protect jobs, China is seeing a steady flow of funds into its bonds, stocks and investment projects because of their better returns and this inflow is expected to continue into next year.

The Chinese government's 10-year bond now yields around 3.3 per cent, while the US Treasury 10-year note yields around 0.90 per cent and the benchmark German government 10-year bond yields a negative 0.6 per cent.

While the currency's momentum could give Beijing a chance to advance its strategic goal of boosting the international profile of the yuan, authorities do not want the currency to strengthen too much because it would affect the other priorities, said Ding Shuang, chief China economist at Standard Chartered.

The People's Bank of China (PBOC), the nation's central bank, is likely to take action if the currency rises too far or too rapidly in the future, Ding said, adding that yuan appreciation of more than 5 per cent within one year on a trade-weighted basis is likely to be seen by Beijing as "excessive", since it would more than offset any gains in competitiveness in that period.

Standard Chartered predicted last week that the US dollar-yuan exchange rate would rise to 6.30 by the end of the first quarter of 2021, driven by China's strong growth, the better returns on financial investments like stocks and bonds, the nation's solid trade surplus and US dollar weakness.

Chinese authorities will seek to dampen expectations of a one-way appreciation trend and prevent the exchange rate from overshooting, the bank said, predicting the exchange would retreat to 6.45 by the end of next year as China's economic overperformance becomes less pronounced.

"For the long term, the proposed 14th five-year-plan aims to upgrade China's production chain and keep the manufacturing sector's share of the economy basically stable. We think the government will be keen to avoid [yuan] overvaluation, which would run counter to these goals," said Ding.

To curb the currency's rise, the PBOC could allow more capital outflows, encourage overseas direct investment that is consistent with companies' core businesses and resume the use the countercyclical adjustment factor in setting the midpoint of the yuan's daily allowable trading range to signal its preferences.

The PBOC sets a daily reference rate for the yuan against the US dollar, which forms the centre of its allowable trade range for the day and reflects its intention for the currency. The yuan is allowed to rise or fall by 2 per cent on either side of the daily parity, which the PBOC often uses to signal to the market its stance for the currency.

Like Citigroup's Liu, Deutsche Bank chief economist Yi Xiong also expects the yuan to strength throughout next year, projecting a rate of 6.20 at the end of 2021.

US dollar-yuan exchange rate: what is it and why is it important?

After a record 6.8 per cent contraction in the first three months of this year, China's overall economy has bounced back strongly, posting growth rates of 3.2 per cent in the second quarter and 4.9 per cent in the third.

Data for October and November also suggested growth will accelerate further in the fourth quarter.

Sentiment in the services sector rose strongly in November, joining the rise in manufacturing that started earlier in the year and indicating that the economic recovery is becoming more broad based.

And China's exports surged 21.1 per cent in November from a year earlier, the fastest pace in almost three years and the sixth consecutive month of export growth, as Chinese factories continue to capitalise on demand for products to fight the coronavirus as well as for electronics and household goods to support the stay at home culture in the West.

The string of upbeat data has led some economists to predict that China will soon start to scale back on fiscal and monetary stimulus that have helped support the economy this year.

The PBOC has already started to act and on Friday reduced Chinese firms' ability to borrow overseas, linking the move directly to their foreign exchange activity.

The move will "further improve the macroprudential management of cross-border financing and guide financial institutions to adjust their foreign exchange asset and liability structure in a market-based way," the PBOC said.

"Financial institutions should establish a 'risk-neutral' concept to better serve the development of the economic society."

In October, the central bank also lowered the reserve requirement ratio for financial institutions when conducting certain foreign exchange forwards trading to zero to curb the surging yuan.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2021 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2021. South China Morning Post Publishers Ltd. All rights reserved.

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Source: https://finance.yahoo.com/news/chinas-yuan-continue-rise-against-093000371.html

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