China need not manipulate the RMB exchange rate

Note: The following is an edited translation of a commentary from the Chinese-language "Commentaries on International Affairs."

In response to the recent accusation by the United States that China is manipulating the exchange rate of its currency, the Renminbi (RMB), the International Monetary Fund (IMF) Chief Economist Maurice Obstfeld recently told the American media that "there is no evidence of manipulation". An assessment by the IMF showed that the value of the RMB is in line with the underlying economic fundamentals.

According to the IMF definition, exchange rate manipulation refers to a protracted, large-scale, one-way intervention by a country of its currency exchange rate in order to obtain an unfair advantage in trade. The accusation that China manipulates its currency stands in contrast with its market-oriented reforms of the RMB exchange rate. As China's Foreign Ministry spokesperson Geng Shuang said, the exchange rate is mainly determined by market supply and demand, and so has both ups and downs. 

Maurice Obstfeld, Economic Counsellor and Director of Research at the International Monetary Fund (IMF), shows the newly-released 2018 External Sector Report at a press conference in Washington D.C., the United States, on July 24, 2018. [Photo: Xinhua]

There are three main reasons why China lacks a motive to manipulate its exchange rate to stimulate exports. 

First, China’s domestic consumption has become the dominant force in China's economic growth. In the first half of the year, China's gross domestic product (GDP) grew by 6.8 percent. Consumption accounted for 78.5 percent of GDP. Net exports were negative, reflecting China's reduced dependence on exports for economic growth. The ongoing upgrading of its domestic production and household consumption, and the rapid modernization of its service industry, are now the main drivers of its economy.

Second, the expansion of China's opening up provides a solid foundation for RMB assets. Compared with European and American financial markets, China's market has higher returns and greater potential. With the deepening of opening up and the advancing internationalization of the RMB, RMB-backed assets are increasingly favored by overseas institutions. This can be seen in the large increase in holdings of Chinese treasury bonds by foreign institutions that was reported in June. It is expected that overseas funds will continue to flow in, and that cross-border capital flows will be balanced.

Third, the potential costs of depreciating the RMB outweigh the gains. Since the beginning of this year, China has introduced measures to expand its imports. A depreciation of the RMB would increase import costs at a time when China's growth in imports is much higher than its growth in exports (Imports grew 11.5 percent while exports grew 4.5 percent in the first half of 2018), so the adoption of an RMB depreciation strategy would result in a net loss. 

So, how should people view the recent fluctuations in the RMB exchange rate?

The Trump administration's trade protectionism has stimulated global risk aversion. This has affected the entire foreign exchange market, causing fluctuations in American stocks, rising market uncertainty, and a continued fall in commodity prices. As a result, the recent fluctuations in the RMB exchange rate are indicative of market sentiment.

The recent fluctuations are also related to the strength of the U.S. dollar index. In the first half of the year, the U.S. dollar index rose by 2.45 percent, but the central parity rate of the RMB against the dollar was only lowered by 1.67 percent over the same period – far below the increase in the dollar index. Therefore, the volatility of the RMB is market compensation under conditions of higher market risks. As the U.S dollar appears to be stabilizing, the RMB is less likely to depreciate further.

And lastly, it is related to the hike in the interest rate by the U.S. Federal Reserve. Since April, the RMB has depreciated by more than 8 percent against the dollar. During this period, American monetary policy has seen interest rates rise and a reduction in the size of the balance sheet. The Federal Reserve raised interest rates twice – in March and again June – and raised the number of rate hikes from three to four this year. At the same time, it has reduced the size of the balance sheet by introducing measures to soak up liquidity. 

By comparison, the People's Bank of China, the country's central bank, adheres to a stable and neutral monetary policy, using forward-looking fine-tuning to manage the money supply. The recent fluctuations in the RMB exchange rate have been within a reasonable range, and the RMB remains a relatively strong global currency.

Two-way exchange rate fluctuations are the result of market action. With China's economy running well and a balanced supply and demand of foreign exchange, the RMB exchange rate has the conditions required to remain stable and at a reasonable level now and into the future. Given this reality, China has no need to intervene in the RMB exchange rate.

(By Dong Ximiao, a senior research fellow at the Chongyang Institute for Financial Studies at Renmin University of China)