ANALYSIS: Economic Pressure Forces China’s Central Bank to Implement Gradual Currency Depreciation Policy

A man wearing a mask walks past the headquarters of the People's Bank of China, the central bank, in Beijing, China, on Feb. 3, 2020. (Jason Lee/Reuters)

Against the backdrop of a strengthening U.S. dollar and a continuous decline in the Chinese yuan’s exchange rate against the dollar, China’s central bank, the People’s Bank of China (PBOC), has implemented a policy of gradual yuan depreciation, drawing significant attention. Since the beginning of the year, the yuan has depreciated by 2.1 percent against the dollar.

The PBOC has long tightly controlled the exchange rate of the yuan against major world currencies, such as the U.S. dollar.

As of May 31, US$1 was exchanged for 7.242 yuan, compared to 7.1106 yuan a year earlier on the same date. On Jan. 1, the rate was 7.0896 yuan per U.S. dollar, and on May 29, it hit the year’s lowest point at 7.2504 yuan.

Throughout this year, the daily reference rate set by the PBOC has ranged between 7.09 and 7.11. However, recently, the market exchange rate dropped 2 percent below the reference rate, the first occurrence in eight years.

On May 29, before the foreign exchange market opened, the PBOC set the midpoint rate at 7.1106 yuan per U.S. dollar, the lowest since Jan. 23 this year but still over 1400 basis points higher than Reuters’ forecast.

To prevent the yuan from depreciating too quickly and to maintain a relatively stable exchange rate, several major state-owned Chinese banks have recently been buying the U.S. dollar in the offshore market and selling it in the spot market. The global financial market has taken notice of this gradual depreciation policy.

There are multiple factors contributing to the yuan’s depreciation. One of the major reasons is the continued growth of the U.S. economy and a strong U.S. dollar.

Recently, the yield on U.S. Treasury bonds has continued to rise, reaching its highest point in four weeks. On May 28, the Conference Board reported a significant improvement in the U.S. consumer confidence index for May, rising from 97.5 in April to 102, the first increase in four months, indicating a positive economic growth trend.

The rise in Treasury yields and positive U.S. economic data have strengthened the dollar in the global financial market, directly leading to a weaker yuan and contributing to its depreciation against the dollar.

Reasons for China’s Yuan Depreciation Policy

Frank Tian Xie, a professor in business at the University of South Carolina Aiken, spoke to The Epoch Times and said that the news surrounding China’s plan to gradually depreciate the yuan is credible.

“The People’s Bank of China has long manipulated the exchange rate, allowing it to fluctuate only within a very narrow range,” he said. “However, as the economy declines and as exports weaken, shifting from exports to Europe and the United States to Russia and Southeast Asia, these exports cannot bring in enough hard currency like the dollar and euro. China earns some rubles, which are of no help in maintaining the RMB exchange rate.”

Mr. Xie pointed out that maintaining a rising exchange rate under such circumstances is costly and the cost will only increase. Europe and the United States will respond if the yuan depreciates too much. Currently, China is engaged in low-cost dumping of goods on the international market. If the yuan drops further, such accusations will become more valid.

He said, “China has no choice but to take this approach because it cannot continue to maintain the exchange rate. So, it has adopted a controlled, gradual, but steady depreciation approach.”

CCP’s Massive Debt

Besides a strong dollar, other factors, such as the Chinese Communist Party’s (CCP) massive local debt and extensive currency issuance, have also diluted the yuan’s value.

According to a report by China’s National Institute for Finance and Development, the country’s debt-to-GDP ratio surged 287.8 percent in 2023, an increase of 13.5 percentage points from the previous year.

The CCP’s official data shows that as of the end of 2023, the outstanding local government debt exceeded 40 trillion yuan (US$5.5 trillion). This is only the explicit debt, while the implicit debt is believed to be even larger. Estimates by the International Monetary Fund (IMF) and Wall Street investment banks put China’s implicit local debt total at between $7 and $11 trillion.

According to China’s Ministry of Finance, from January to April, local governments issued new bonds totaling 970.8 billion yuan (US$134 billion), and refinancing bonds totaling 947 billion yuan (US$130.7 billion). In April alone, local government bonds amounted to 1.9178 trillion yuan (US$264.8 billion), including 637.5 billion yuan (US$88 billion) in general bonds and 1.2803 trillion yuan (176.75 billion) in special bonds.

On April 9, American credit rating agency Fitch indicated that China’s economy can no longer rely on its old growth model and faces increasing uncertainty, with public finances showing risks. Fitch also revised China’s long-term foreign debt rating from stable to negative.

On April 16, Fitch downgraded the credit ratings of six major Chinese state-owned banks from stable to negative due to enormous pressure and concerns over the Chinese regime’s ability to provide support when banks are under stress.

On May 25, Du Wen, a former Chinese government official, posted on X that China is undergoing an unprecedented economic crisis, with local debt being particularly problematic. He said that officials within the regime believed that local debt would crush the Chinese economy and would become the trigger for the collapse of the CCP.

Moreover, in Dec. last year, Moody’s downgraded the ratings of eight Chinese banks from stable to negative.

China’s Ministry of Finance announced plans on May 13 to issue ultra-long-term special treasury bonds starting this year, with an initial issuance of 1 trillion yuan ($138 billion). This year’s ultra-long-term sovereign bonds have terms of 20, 30, and 50 years.

This year’s CCP government work report states that the issuance of ultra-long-term treasury bonds will continue for several years. Based on China’s economic and fiscal situation, most of the funds from these special treasury bonds are believed to be directly transferred to heavily indebted local governments.

Reasonable Exchange Rate

Gita Gopinath, the first deputy managing director at the IMF, recently suggested that China’s central bank should consider making the yuan exchange rate more flexible to reduce deflation and help absorb external pressures.

Mr. Xie explained that the CCP cannot afford to give up control over the exchange rate at this time. He said, “A reasonable exchange rate can only be reflected under truly open exchange conditions.”

In his 2013 book “The Dragon’s Vault,” Mr. Xie estimated that, based on the amount of currency issued by the CCP and factors such as productivity in China and the United States, if there were complete free exchange, $1 could potentially be exchanged for 20 to 30 yuan. However, the CCP does not dare to allow free exchange.

Financial policy is a barometer of economic conditions, and PBOC’s policy of gradually depreciating the yuan indicates that China’s economy is facing severe challenges.

Mr. Xie believes that China’s current economic system can collapse at any time. “China’s old economic drivers have stalled, and the new drivers have been defeated by Europe and the United States before they even started, reverting to their original state,” he said.

Jane Tao and Bin Zhao contributed to this report.