The RMB exchange rate has broken “7”! What are the implications?

On September 15, Beijing time, in the foreign exchange market, the offshore yuan’s spot exchange rate against the U.S. dollar fell below the round-number threshold of “7.” After more than two years, the yuan-to-dollar exchange rate has once again entered the “7” era.

What will the future trend be? What impacts will there be after “breaking 7”?

Based on authoritative views from official sources and experts, Guoshi Zhitongche has launched a “Ten Questions and Ten Answers” series:

1

Is it really a good thing that the RMB exchange rate against the U.S. dollar has broken “7”? How should we view this?

National Channel Direct: The RMB exchange rate has broken the “7” mark—but it’s really not as serious as everyone thinks. It’s just a price, and it’ll definitely rebound; that’s inevitable.

When the renminbi broke the “7” mark in 2019, the central bank pointed out that the renminbi exchange rate “breaking 7” is neither an age—once it’s passed, there’s no going back—or a dam—once breached, the floodwaters will rush uncontrollably downstream. Rather, “7” is more like the water level in a reservoir: during the wet season, the level rises higher; during the dry season, it falls lower. Fluctuations up and down are perfectly normal.

Everyone should recognize that the RMB exchange rate does not have the foundation for long-term depreciation, nor will it experience a one-way trend of continuous decline or continuous appreciation.

Even though the exchange rate has now broken through the “7” mark, with China’s economy stabilizing in the future, the U.S. dollar index retreating, and the appropriate use of certain policy tools, it’s inevitable that the exchange rate will once again rise back into the “6” range.

In fact, the impact of exchange-rate fluctuations has long been a well-worn topic. A depreciation of the currency has both advantages and disadvantages. Moderate depreciation can help enhance the competitiveness and price advantage of export trade, thereby boosting the recovery of the real economy; however, it will also increase import costs for companies that rely on imports.

For example, in China’s export trade, footwear and accessories, textiles and apparel, and leather goods and luggage account for a significant share. A moderate depreciation of the RMB could benefit companies operating in these sectors. On the flip side, industries that rely on importing raw materials, goods, and services from overseas, as well as companies holding larger amounts of U.S. dollar-denominated bonds, might face negative impacts.

2

On September 6, the central bank lowered the reserve requirement ratio for foreign exchange deposits held by financial institutions by 2 percentage points. So why is the exchange rate still continuing to depreciate?

China’s Direct Channel: First, the central bank announced the “interest rate cut” for foreign exchange on September 6, but it was not implemented on that very day. Starting September 15, 2022, the central bank will lower the reserve requirement ratio for foreign exchange deposits held by financial institutions by 2 percentage points—bringing the ratio down from the current 8% to 6%.

So in recent days, the FX “rate cuts” have been more of a signaling effect—essentially sending a message to the market that if irrational depreciation were to occur, the authorities would not stand by and do nothing.

3

Does the depreciation of the RMB mean that money is worth less? And could this depreciation drive up import costs, thereby leading to higher prices?

National Direct Line: The “devaluation” of the RMB is only evident when using RMB to purchase U.S. dollars. Indeed, when settling import transactions that require U.S. dollars, import costs will rise.

However, please note that if the import settlement is conducted in euros, yen, or pounds sterling, the actual costs have been declining recently, as the renminbi has actually appreciated relative to these currencies.

As for the issue of rising prices, the vast majority of items included in China’s CPI—food and daily necessities—are domestically self-sufficient. Therefore, the depreciation of the RMB against the U.S. dollar has little impact on domestic prices.

4

Whether it’s rising or falling, if I only use RMB for domestic consumption, wouldn’t the depreciation of the RMB exchange rate have no impact on me?

National Direct Line: Not necessarily. If the products you consume domestically are imported and settled in U.S. dollars, or if their components are purchased using U.S. dollars, then the depreciation of the RMB could be passed on to the prices of the products you’re buying, making them more expensive.

To give you the simplest example, if you’re shopping online through cross-border e-commerce in China and your final consumption is priced in U.S. dollars, then this will have an impact on you.

5

With so much money being printed, why is the U.S. dollar still worth so much? Is the U.S. dollar appreciating against all major currencies worldwide?

National Direct Line: Four words—dollar hegemony. As former U.S. Treasury Secretary Connally once said, “Our dollar, your trouble.”

Generally speaking, if money keeps being poured out and “flooded” recklessly, its value will inevitably decline. But the crucial issue is that the U.S. dollar holds an absolute monopoly position in various global arenas—including trade, payments, finance, and foreign exchange reserves.

So, the “liquidity flood” unleashed by the Federal Reserve is actually being absorbed globally. By raising and lowering interest rates, the Fed can control the flow of this liquidity and the price of the U.S. dollar. The appreciation of the U.S. dollar this year has been driven by the Fed’s subsequent interest-rate hikes—hikes that began after the massive liquidity injection earlier in response to the pandemic, as dollars flowed back into the domestic market, thereby pushing up the dollar’s value.

6

Not only is the renminbi depreciating, but currencies of other countries are also losing value against the U.S. dollar. Will rising import costs end up being “paid for by everyone”?

Guoshi Zhitongche: “It’s not just the RMB that’s depreciating”—that’s indeed the current reality. As mentioned earlier, the euro, yen, and British pound have all fallen even more sharply than the RMB. Therefore, compared to these non-U.S. currencies, the RMB has actually appreciated.

Both price advantages and product strengths are crucial factors in determining business success. At this stage, to assess export competitiveness, it’s essential to conduct a detailed analysis tailored to different industries.

As for the increase in import costs, on the one hand, most of the goods included in our CPI basket can basically be produced domestically, so there’s no need to worry too much about it. On the other hand, some goods are affected by exchange-rate fluctuations, leading to higher costs. However, China has a well-established pricing mechanism for many essential daily necessities, and the final prices determined through this mechanism don’t necessarily mean that the entire population will have to bear the full cost.

7

As the renminbi continues to depreciate, will capital start “fleeing” overseas?

National Direct Line: It’s undeniable that, in this round of RMB depreciation, some capital will certainly flow out. However, such capital generally has short-term investment objectives or even speculative motives. At present, China’s foreign exchange market is operating normally, and cross-border capital flows remain orderly.

Last weekend, Zheng Wei, Deputy Director of the State Administration of Foreign Exchange, stated that currently, China’s cross-border capital flows are generally stable, and the supply and demand for foreign exchange both domestically and internationally remain broadly balanced. The fundamental outlook for China’s economy—characterized by long-term positive trends—has not changed, and the country continues to attract direct investment as well as capital inflows aimed at medium- and long-term asset allocation.

In the first half of 2022, China’s net inflow of direct investment reached US$74.9 billion, of which net inflow of foreign direct investment into China totaled US$149.6 billion, demonstrating that the Chinese market continues to hold strong appeal for foreign investors.

8

The U.S. has been raising interest rates recently. Is now the right time to invest in dollar-denominated savings products or buy gold?

National Direct Line: Indeed, at present, the interest rates on U.S. dollar deposits in some banks have already surpassed those on RMB deposits. However, it’s important to note that high interest rates on U.S. dollar deposits don’t necessarily guarantee high returns, because the final yield also needs to take into account fluctuations in exchange rates.

For example, suppose the current interest rate on U.S. dollar deposits is 3.5% per year. If, over the course of the year, the renminbi appreciates against the U.S. dollar by just 4%, bringing the exchange rate from its current level to around 6.6, you’d still end up losing money—in fact, you’d lose even more once you factor in the currency conversion fees. It’d be like trying to catch water with a bamboo basket—totally futile.

Moreover, the RMB’s exchange rate now exhibits greater flexibility in both directions. A level of 6.6 was already seen three or four months ago, and it’s entirely possible for the exchange rate to rebound over the next year. So don’t try to bet on exchange rates—after all, no one can predict them accurately.

As for gold, everyone believes it’s an excellent safe-haven asset—but it’s not a safe haven against RMB depreciation. Looking at this round of RMB depreciation and the previous one earlier this year, gold prices have hardly changed at all. Investing in gold still requires paying close attention to the overall international situation and the movements of the U.S. dollar.

9

Why is it necessary to lower the foreign exchange reserve requirement in order to stabilize the exchange rate? How exactly does this mechanism work?

National Direct Line: At its core, the exchange rate between the RMB and the U.S. dollar is simply a price—and prices are determined by supply and demand. When the foreign exchange reserve requirement ratio is lowered, it releases additional U.S. dollar liquidity, increasing the supply of U.S. dollars in the foreign exchange market. As a result, the U.S. dollar will no longer be so expensive.

10

With the RMB exchange rate breaking 7, what other tools does the central bank have at its disposal to regulate the exchange rate?

National Direct Line: No central bank in any country would allow its currency to appreciate or depreciate rapidly.

The People's Bank of China has a wide array of monetary policy “toolkits” and is highly experienced in countering speculative activities in the foreign exchange market. Over the past several years, it has consistently emerged victorious in its “battles” against short sellers of the renminbi.

In addition to the already implemented foreign exchange risk reserve requirement, at present, the central bank still has several tools at its disposal to prevent a rapid depreciation of the exchange rate, including the countercyclical factor, the foreign exchange deposit reserve requirement for financial institutions, and the macroprudential coefficient for cross-border investment and financing.

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