Original title |Analysis of the trend of the RMB exchange rate and its impact on the banking industry
The main reason for the change in the RMB exchange rate.
In the past two years, the monetary policy of China and the United States has gone in the opposite direction, and the interest rate differential has been widening. After the outbreak of the new crown epidemic, the United States adopted extremely loose fiscal and monetary policies, and the economy recovered strongly, but inflation rose to a four-decade high. To control inflation, the Federal Reserve has tightened monetary policy sharply. In March 2022, the Federal Reserve began raising interest rates aggressively. As of December 2023, the Fed has raised interest rates by a cumulative 525 basis points, and the federal target rate (lower bound) has risen from zero to 525%。Market interest rates such as U.S. interbank interest rates, Treasury yields, and deposit and loan rates have also risen sharply.
Unlike the U.S., which first cut interest rates sharply and then tightened its monetary policy, China has adopted a policy model of easing in small steps since the pandemic. In terms of money market interest rates, the People's Bank of China (PBoC) has lowered the 7-day reverse repo rate six times since 2020, with a total of 70 basis points, reducing the 7-day reverse repo rate from 25% to 18%。In terms of credit market interest rates, the People's Bank of China (PBoC) has lowered the medium-term lending facility (one-year) interest rate six times, by a total of 75 basis points, reducing the medium-term lending facility interest rate from 325% to 25%。Correspondingly, LPR also declined. One-year LPR from 415% to 345%, 5-year LPR from 48% to 42%。Overall, in the past two years, the performance of macroeconomic fundamentals in China and the United States has diverged, and there have been differences in monetary policy orientation, which has led to a significant divergence in the trend of a series of policy interest rates and market interest rates.
It should be noted that this phenomenon is not an exception, and there have been periods of divergence in the monetary policies of China and the United States in history. Since the 2008 financial crisis, there have been three typical divergences between monetary policy and interest rates between China and the United States. The first was from mid-2009 to mid-2011. After the outbreak of the financial crisis, China's economy took the lead in a strong recovery. From 2010 to 2011, the People's Bank of China raised the benchmark lending rate five times. The U.S. economy is recovering significantly slower than China's. In 2009, although GDP growth has turned positive and the recession has emerged, the unemployment rate is still above 8%. The Fed maintained its zero interest rate policy and started large-scale quantitative easing, and market interest rates are still falling. There is a significant divergence in monetary policy between China and the United States. The second time was from 2014 to 2016. The U.S. economic recovery is gaining momentum, and the unemployment rate has fallen below 6%. At the end of 2015, the Federal Reserve officially started raising interest rates. At the same time, China's economic cycle is heading for a downward phase. From the end of 2014 to the beginning of 2016, the People's Bank of China (PBoC) lowered the benchmark lending rate by a total of 140 basis points six times and implemented five comprehensive RRR cuts, marking the second divergence between the monetary policies of China and the United States. The third time was from the end of 2017 to the beginning of 2019. Affected by factors such as Sino-US friction, China's economy is under pressure. The People's Bank of China (PBoC) has cut the reserve requirement ratio (RRR) five times across the board, and market interest rates have dropped significantly. In the same period, the U.S. economy maintained steady growth, the Federal Reserve continued to raise interest rates slowly, and the monetary policies of China and the United States diverged again.
Since 2023, the gap between China's and the United States' economic fundamentals and monetary policy has continued to widen. Entering 2023, the road to domestic economic recovery has not been smooth sailing, and after a larger-than-expected recovery in the first quarter, the slope of the domestic economic recovery has slowed down at the beginning of the second quarter. Since then, China's monetary policy has been continuously increased: since June, the central bank has twice lowered policy rates such as medium-term lending facilities, and in September, the reserve requirement ratio was lowered by 25 basis points. However, the economic fundamentals of the United States in 2023 have shown extraordinary resilience, which has also made the US job market much tighter and inflation stickier than the Fed expected. In response to price pressures, the Fed has had to adopt a tougher tightening stance. In 2023, the Fed will raise interest rates four times, raising the monetary policy rate by 100 basis points, which has also led to the strong performance of the US Treasury interest rate and the US dollar index, and the inversion of the 10-year Treasury bond interest rate in China and the United States once exceeded 2%.
Against the backdrop of widening interest rate differentials between China and the United States, the RMB exchange rate is under obvious pressure. Since the beginning of 2023, the RMB exchange rate has once again entered the depreciation channel, and the onshore RMB exchange rate has dropped from the lowest of 6 in mid-JanuaryAround 7 all the way down to 7 in early September35. The offshore RMB exchange rate also depreciated significantly.
The flow of international capital has played an important role in the current round of RMB depreciation: against the backdrop of aggressive interest rate hikes by the Federal Reserve, international capital flows to major developed economies. In the first half of 2023, the United States, the United Kingdom, Japan, Canada, and Germany became the world's top five destinations for cross-border capital flows. Among them, the trend of global capital flow to the United States is more obvious. According to statistics, from 2018 to 2022, cross-border capital flows to the United States accounted for 26 percent of total cross-border capital flows1%, while the proportion rose to 33 in the first half of 20239%。From January to June 2023, the U.S. financial account surplus rose to its highest level since 2015, reaching $459 billion.
Against the backdrop of widening interest rate differentials between China and the United States, China is showing greater pressure on capital outflows. In the first half of 2023, China's balance of payments financial account deficit was US$126.6 billion, showing significant net capital outflows. If we simply look at the financial project, which is the most direct measure of financial capital flows, China's net capital outflow has reached the peak since 2009 since 2021.
However, there seems to have been some changes in the trend of the renminbi recently: since November, the exchange rate of the onshore and offshore US dollar against the yuan has increased from 73 or more, up to 71, the appreciation rate is nearly 3%. At the same time, the difference between the central parity of the RMB exchange rate and the market parity has also narrowed rapidly. There is a view that the appreciation of the RMB exchange rate in the past two months may be supported by seasonal changes in foreign exchange demand and the policy of stabilizing the exchange rate. Under the influence of seasonal factors such as the end of the dividend season of Hong Kong-listed companies, the rebound in foreign exchange settlement demand from exporters, and the increase in overseas commodity imports during the Christmas season, the RMB exchange rate tends to strengthen at the end of the year, such as since 2017, the RMB exchange rate has appreciated to varying degrees in the fourth quarter. In addition, the end of the year and the beginning of the year are the time points when various major domestic conferences are held, and policy expectations usually heat up accordingly. Since 2023, various financial conferences and policy documents have released strong signals of "stabilizing the exchange rate", which makes it easier for the RMB exchange rate to get out of appreciation**.
However, compared to the above factors, the weakening of the US dollar index may be the main reason for the recent appreciation of the yuan. From a time perspective, the current round of RMB appreciation is highly consistent with the beginning of the rapid decline of the US dollar index, which occurred on November 2. At the same time, the recent appreciation of the RMB exchange rate is similar to that of the US dollar index and other non-US currencies: in the one-month period from November 2 to December 2, the US dollar index totaled **32%, and the onshore and offshore RMB exchange rates appreciated by .9%, and the yen, which is also a major Asian currency, appreciated by 27%, but the renminbi exchange rate has not appreciated excessively relative to other currencies. The CFETS RMB exchange rate index, which represents the exchange rate of a basket of currencies, instead increased from 99 on November 311 fell to 98 on November 3029。All of the above phenomena indicate that the driving factors of the recent appreciation of the RMB exchange rate are "outside" and not "inside".
After bottoming out in the third quarter**, the fundamentals of the U.S. economy have shown signs of weakening again since October. U.S. nonfarm payrolls rose by 150,000 in October, below consensus expectations of 180,000. At the same time, the unemployment rate rose to 39%, the highest level since January 2022, and other data such as CPI and PMI, which have also attracted market attention, have also fallen short of expectations. All of the above factors have led to a significant cooling of the market's tightening expectations for the Fed, and the US dollar index has risen and retreated. In addition, the pace of bond issuance by the U.S. Treasury slowed down in November, and the net issuance of Treasury bonds in November was only $217.1 billion, less than half of that in October. This has also marginally improved the liquidity position of the US dollar, which is positive for US bonds and weighs on the US dollar index.
Outlook for the RMB exchange rate.
Looking ahead to 2024, the USD/RMB exchange rate is expected to recover within "7". Although it is difficult to see obvious positive factors driving the RMB exchange rate to continue to appreciate in the short term, from a medium-term perspective, the narrowing of the gap between the economic fundamentals and monetary policies of China and the United States is relatively certain, and the RMB exchange rate will also benefit from this.
On the one hand, the domestic economy is expected to continue to recover in 2024. Looking back on 2023, the domestic economic recovery is obviously less than market expectations, and the important reason behind this is that the policy side has maintained considerable determination, but this also leaves room for subsequent policy increases. Although China's real GDP growth rate is expected to be higher than 5% in 2023, the two-year average growth rate is actually only about 4%, which means that stronger policies to stabilize growth will need to be introduced in 2024. The ** Economic Work Conference held in December 2023 determined the policy tone of "seeking progress while maintaining stability, promoting stability with progress, and establishing first and then breaking down", which is more positive than the statement of "seeking progress while maintaining stability" at the July meeting. In addition, in addition to the previous statements such as "strengthening the counter-cyclical and cross-cyclical adjustment of macro policies", it is also straightforward to point out that it is necessary to "have more policies that are conducive to stabilizing expectations, stabilizing growth and stabilizing employment", which means that on the basis of the current policy, the follow-up policies are expected to continue to increase, and the domestic economic fundamentals will also improve. On the other hand, judging from the current inflation and employment situation in the United States, the U.S. economy may continue to cool slowly in 2024, and the need for the Fed to raise interest rates further is not high, and the current Fed interest rate hike cycle is likely to be over. At present, the fundamentals of the US economy continue to weaken, but the downward slope is slower than market expectations. In the United States, real interest rates have turned positive, and the stance of monetary policy has been tightened enough. The dot plot of the Fed's interest rate meeting in December shows that the Fed may cut interest rates three times in 2024, and Fed Chairman Powell's statement after the meeting is also obviously "dovish". All of the above signs indicate that after about a year and a half of tightening, the Fed's rate hike cycle is over, and the Fed's policy rate and US Treasury rates are expected to fall in 2024. Therefore, the difference between monetary policy and market interest rates between China and the United States is expected to gradually narrow in 2024, and after a period of time, the RMB exchange rate may usher in a new round of appreciation.
The impact of RMB exchange rate changes on the banking sector.
Fluctuations in the RMB exchange rate can have a significant impact on banks' balance sheets. Changes in the RMB exchange rate will also affect banks' foreign currency capital, foreign exchange liabilities and foreign exchange assets. Among them, in the case of a sharp appreciation of the renminbi or a sharp depreciation of the US dollar, the capital of commercial banks will be seriously reduced, increasing the exchange rate risk of banks. The increase in exchange rate risk will also lead to an increase in the total amount of risk assets of banks, which in turn may lead to a decline in the capital adequacy ratio of banks and expose banks to higher risks. In addition, exchange rate fluctuations can also cause large fluctuations in foreign exchange deposits. If the renminbi is expected to appreciate, the scale of foreign exchange deposits will be greatly reduced, and the scale of foreign exchange loans will increase, resulting in a rising loan-to-deposit ratio, and there may be a mismatch between assets and liabilities. The imbalance in the structure of foreign exchange assets will also increase the liquidity risk of commercial banks.
Increased uncertainty in banking operations. For example, fluctuations in the RMB exchange rate may affect banks' loan pricing. When the RMB exchange rate appreciates, borrowers' repayment costs may rise, which may lead to an increase in loan defaults. Conversely, when the RMB exchange rate depreciates, the borrower's repayment cost may decrease, but this may also reduce the bank's loan yield. In addition, the appreciation of the renminbi in the encouragement of imports but also inhibited exports, the relative reduction of the import industry, so that the import volume increased, the volume of import settlement business increased; The relative increase in exports has reduced the competitiveness of export products, the scale of exports has decreased, and the volume of export settlement business has been relatively reduced. The dual impact of exchange rate changes on international ** has led to the uncertainty of the total volume of international settlement business of commercial banks, and will have a greater impact on the structural changes of international settlement business.
Risk management pressure on banks has risen. Changes in the total assets and liabilities of banks and their structure have increased the uncertainty of business operations, further increased the exchange rate risk of commercial banks, and thus increased the pressure on their risk management, especially their ability to avoid and manage exchange rate risks. Due to the uncertainty of exchange rate fluctuations, banks may need to adjust their foreign exchange positions and risk management strategies more frequently, and continuously innovate exchange rate risk management tools and techniques, such as the use of foreign exchange derivatives and the establishment of foreign exchange risk management systems, to reduce the negative impact of exchange rate fluctuations on the bank's business, which may increase the bank's operating costs and risk management difficulties.
However, the two-way fluctuation of the exchange rate also brings opportunities for banks to innovate their business. With the fluctuation of the RMB exchange rate, the demand for cross-border finance has gradually increased. Banks can take advantage of the opportunities brought about by exchange rate fluctuations to carry out cross-border financial innovations, such as cross-border loans, cross-border financing, cross-border settlement, etc. In the case of RMB appreciation, banks can provide more professional financial consulting services for export-oriented enterprises to help them manage foreign exchange risks. The innovation of this service model can not only improve the business level of the bank, but also enhance the competitiveness and profitability of the bank.
Author Affilications:Institute of World Economics and Politics, Chinese Academy of Social Sciences, Jiufang Institute of Finance, among which Xiao Lisheng is the director of the Global Macroeconomic Research Office of the Institute of World Economics and Politics, Chinese Academy of Social Sciences.
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