Forex Comment Apr 08

Chinese yuan plunges in March as foreign exchange reserves decline

But foreign trade figures are expected to continue to be strong, so the yuan is unlikely to suffer a substantial exchange rate decline

Chinese yuan plunges in March as foreign exchange reserves fall
Image: Reuters.

(ATF) After the fastest appreciation in history last year the exchange rate of the RMB/yuan suddenly hit turbulence in March, which saw a month of decline, and has led to head scratching on whether the Chinese currency will start appreciating again – or is this turnaround a longer-term trend?

The offshore RMB exchange rate against the US dollar fell from 6.46 in early March to 6.58 in early April, for a cumulative decline of 1,200 basis points. And behind this, a big driving force was a reduction in foreign exchange reserves. China's foreign exchange reserve balance was US$3.17 billion in March, a decrease of $35 billion from February, which is almost 200 billion yuan.

The loss of foreign-exchange reserves can of course cause a devaluation of the renminbi. But finance papers in China have predicted that the country's trade in March will still maintain a surplus. Although trade data has not been released yet, judging from the trend of a sharp increase of 60% year-on-year in foreign trade from January to February, the data in March should continue to be eye-catching.

The main reduction in foreign exchange reserves should be through the outflow of capital accounts. This is the so-called "hot money" outflow. Many of these funds are speculative in nature, and a considerable part of them are invested in the stock market. 

In addition, the US dollar also maintained a strong appreciation trend in March, mainly due to the soaring yields of US Treasury bonds. It is believed that the US economy will see inflation in the future, but nothing is certain. Therefore, investors believed that Treasury bonds could not beat inflation, and government bonds were sold. But the surge in Treasury bond yields also boosted the US dollar index.

The future of the yuan will mainly depend on the strength of the US dollar. However, because China foreign trade has remained strong, it is almost impossible the yuan will suffer a substantial depreciation.

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