A Critical Analysis of the Depreciation of Yen and Its Impacts on Renminbi

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The People’s Bank of China (PBoC) has launched a policy of reducing foreign exchange reserve requirements. The RMB exchange rate against the U.S. dollar initially stabilized and then depreciated sharply. Data on the afternoon of April 28 shows that the onshore RMB/USD exchange rate has fallen below the 6.61 mark for the first time since November 2020, a drop of more than 400 basis points. Meanwhile, the offshore RMB declines below the 6.65 mark against the USD at one point, a fall of more than 600 basis points. The intraday slump in the RMB/USD exchange rate once led to a sharp decrease in the A-share. Fortunately, with the inflow of capital, the A-share market has gradually been restored. When analyzing the economic and financial conditions at home and abroad, ANBOUND’s researchers have earlier stated that geopolitical turmoil and economic pressure are the two leading factors for the cyclical depreciation of the RMB. Coupled with some new factors, it will not only accelerate the depreciation of the RMB but also put further pressure on China’s economy and financial markets.

With little change in the data on exports affecting the exchange rate and no sign of a visible acceleration of capital outflows, weaker sentiment appears to be the most likely explanation for the RMB depreciation. The U.S.-China. interest rate differential and their unique economic cycle have long had a significant impact on the value of the RMB. Recently, the Bank of Japan (BOJ)’s quantitative easing decision and the rapid depreciation of the Japanese yen have impacted stakeholders’ confidence in the RMB.

The BOJ has announced a new monetary policy meeting resolution. The bank decides to keep the benchmark interest rate unchanged at -0.10% and keeps the 10-year treasury bond yield target constant at around 0.0%, which is in line with market expectations. It estimates that GDP growth in the fiscal year 2022 is at 2.9%, compared with 3.8% previously. Meanwhile, the core inflation is 0.9%, compared with 1.1% previously. In the year after that, the bank anticipates core CPI to increase by 1.1%, compared with 1.1% previously, and GDP growth of about 1.9%, compared with 1.1% previously. The BOJ further forecasts that GDP will grow by 1.1% in the fiscal year 2024. The Bank of Japan will conduct fixed-rate operations every working day, buying unlimited quantities of Japanese government bonds and bringing yields close to zero.

The BOJ’s decision to carry on its unlimited quantitative easing leads directly to further depreciation of the yen against the U.S. dollar. On April 28, since the bank announced its interest rate decision, the USD/JPY exchange rate has risen to 129.5, an increase of more than 1% on the day, hitting a new high since 2002. The yen’s depreciation also further pushes up the U.S. dollar index, which has now risen above 103.5, a new high since January 2017. The move weighs on other currencies in the region, including the South Korean won and the RMB. The Bloomberg Dollar Spot Index has risen 0.4% to its highest level since May 2020. The won has fallen about 0.5%, while the onshore RMB has dipped 0.4%. Therefore, for China, the quantitative easing policy of the Bank of Japan has brought about an impact like the policy gap widening between China and the United States, which the former also exposes the instability of the RMB against the U.S. dollar.

Market analysts generally view the widening difference in quantitative easing policy between Japan and the United States, which intensifies the interest rate gap between the two countries, to be the direct reason for the yen’s depreciation. The BOJ insists that the depreciation of the yen is beneficial for the Japanese economy. Quantitative easing would help push up inflation, meeting the policy goals of other central banks in Japan. However, other countries appear to disapprove of the Bank of Japan’s policy on its long-term quantitative easing decision. The market believes that the rise in import prices after the depreciation of the yen will only offset the accompanying competitive advantage in export prices. In other words, quantitative easing will not help the Japanese economy much and will only push up inflation further.

As the U.S. dollar continues to strengthen, the yen’s depreciation will in turn adversely affect the currency stability of other Asian economies. With Japan’s extensive economic and trade influence in the Asia-Pacific region, the depreciation of the yen will impact the currencies of China, South Korea, and Southeast Asia. In addition, the BOJ’s quantitative easing decision, which has fueled speculation in cross-currency arbitrage, could further affect financial turmoil in China and Southeast Asia. These consequences may outweigh the immediate effects of changes in the U.S. dollar. In a sense, the continual depreciation of the yen will exacerbate the adverse impacts of a stronger U.S. dollar on Asia-Pacific economies, similar to a repeat of the 1997 Asian financial crisis.

Soochow Securities reveals that historically, the depreciation of Asian currencies has been highly contagious for two reasons. On one hand, Asian economies share an export-oriented commonality; on the other hand, the exchange rate is beggar-thy-neighbor, and a stronger yen would bring upward pressure on Southeast Asia. This year in 2022, the yen has decreased about 10 percent against the U.S. dollar. Meanwhile, the Korean won has fallen as much as 3.1% against the U.S. dollar at one point in time. Comparatively, the RMB has also declined more than 2.5 percent against the U.S. dollar since late April. In fact, the yen has depreciated against the RMB to a near 30-year low. Such competitive assessment would put more pressure on the RMB.

The central banks of China, Japan, and South Korea have adopted very diverse strategies in the face of falling exchange rates. In particular, the BOJ continues to implement a quantitative easing policy, causing the yen to depreciate sharply. The Bank of Korea follows the Federal Reserve by raising interest rates to keep the won’s value. The PBoC stabilizes the exchange rate by reducing the foreign exchange reserve requirement ratio. With the broadening policy differences, the currency gaps between the three countries seem to be widening, which undoubtedly creates more interference and constraints on the RMB than on the U.S. dollar.

The adverse impacts of the yen’s depreciation, which puts additional pressure on currencies other than the U.S. dollar, would further negatively affect China’s economy and foreign trade. Fundamentally, maintaining the stability of the RMB mainly lies in advancing China’s domestic economic, trade, financial and international geopolitical relations. The market confidence and expectations brought about by stable economic growth will essentially stabilize China’s exchange rate and financial market. Implementing economic stabilization policies is crucial to improving monetary policy and financial market expectations.

Final analysis conclusion:

Geopolitical factors and the COVID-19 pandemic have led to the depreciation of the RMB, which is likely to accelerate as the yen continues to depreciate. This will in turn, further affect China’s exchange rate and economic stability.

Writer by Wei Hongxu
A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK

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