- The People’s Bank of China appears to be quietly intervening through proxy banks to resist upward pressure on the renminbi amid broad US dollar weakness.
- The scale of central bank intervention appears modest; rather than actively weakening the RMB, the PBoC is “leaning against the wind” to restrain excessive appreciation.
- The use of state-owned banks as proxies enables the PBoC to minimize fluctuations in official foreign exchange reserves, avoiding accusations of currency manipulation from trading partners.
Amid broad weakness in the US dollar since May, China’s currency has also strengthened against the greenback, but the degree of renminbi appreciation has been more modest than for other currencies. Since the end of June, the US Dollar Index (DXY) has weakened by 5.1%, but the US dollar has only weakened against by 4.2% against the renminbi. This discrepancy is especially noteworthy because China has absorbed large foreign exchange inflows in recent months, through both trade and investment flows. The relative stability of the renminbi amid broad dollar strength and strong capital inflows raises the question of whether the People’s Bank of China (PBoC) is intervening in foreign exchange markets to restrain renminbi appreciation and maintain export competitiveness.
The answer appears to be yes, but the scale of intervention is modest. The PBoC’s efforts to weaken the renminbi are far less forceful than in the heyday of Chinese exchange-rate intervention in the mid-2000s, when the PBoC accumulated tens of billions of dollars in foreign exchange reserves per month through intervention, prompting US complaints about currency manipulation. Nevertheless, even modest intervention to weaken the renminbi suggests a shift in the PBoC’s policy bias.
Shifting policy bias
In August 2019, when the renminbi’s value against the US dollar weakened beyond the psychologically-significant 7-per-dollar barrier, we suggested that this move was not an act of currency war because renminbi weakness was the result of market forces, not PBoC intervention. On the contrary, we argued that far from encouraging renminbi weakness to boost exports, any PBoC intervention that did occur would likely be in the opposite direction – restraining renminbi weakness to avoid financial instability and capital flight of the type that occurred 2015-16. Indeed, the currency war scenario never materialized, and the renminbi bottoming out at 7.14 per dollar in late May amid the global flight to dollar safety, before strengthening to 6.83 on 9 September amid the dollar’s subsequent correction.
Today the PBoC’s policy bias appears to have shifted towards a weak renminbi, at least incrementally. China’s exports have exceeded expectations during the pandemic, but policymakers likely recognize that this positive trend may soon lose momentum. As the world recovers from Covid-19, elevated demand for Chinese exports of medical equipment will weaken, and other exporting countries will re-engage in export competition with China as their economies recover, even as overall global demand remains sluggish. Though Chinese leaders have recently endorsed a new economic strategy based on increasing domestic demand, policymakers have made clear that they still regard exports as an important pillar of economic growth.
By traditional metrics, Chinese exchange-rate intervention in recent years appears virtually nonexistent. Evidence of such intervention traditionally has traditionally come from monthly data on official foreign exchange reserves. Rising reserves indicate that the PBoC is buying US dollars or other foreign currencies to weaken the renminbi’s value, while falling reserves indicate dollar sales to promote renminbi strength. But forex reserves have been remarkably stable since 2017, hovering around USD 3.1tn, according to official data.
A puzzle has emerged in recent months, however. The extreme stability of China’s headline reserves appears inconsistent with other data suggesting large balance of payments inflows through both trade and investment channels. On trade, China’s monthly trade surplus has averaged 4-5% of monthly GDP for the four months through August. On investment, foreigners have been large net purchasers of Chinese onshore securities this year, according to PBoC data. Chinese bonds have been especially attractive, as the contrast between the Federal Reserve’s aggressive monetary easing and the PBoC’s less aggressive rate-cutting increased the positive interest-rate differential between renminbi and US dollar bonds.
Intervention by proxy
The question, therefore, is where these inflows are accumulating, if not in official reserves. To be sure, some foreign inflows may have been balanced out by various forms of domestic outflows. These outflow channels include repayment of foreign debt as well as “hot money” and illicit outflows, which are typically recorded as “errors and omissions” in official balance of payments data. Still, there is little indication of capital flight on the scale of 2015-16 that could fully balance the large inflows. Balance of payments data for the third quarter will shed some light on this mystery but will not be available until December.
The most likely possibility is that large Chinese state-owned banks are accumulating foreign assets and holding them on their own balance sheets, rather than selling them to the PBoC. At least some of this accumulation is probably occurring on instructions from the PBoC. The effect is therefore similar to the PBoC purchasing foreign assets directly, but the stability of the headline reserves figure enables Beijing to avoid accusations of currency manipulation from trading partners.
Looking ahead, the PBoC remains highly unlikely to pursue large-scale devaluation of the renminbi. Still, signs of subtle intervention to nudge the renminbi weaker indicate a shift in the PBoC’s policy orientation. Whereas its policy bias from 2015 to 2019 was to “lean against the wind” to restrain market forces pushing the renminbi weaker, the current bias has apparently shifted towards preventing excessive strength.