China Doesn't Need to Defend Psychological Level of 7 Yuan per Dollar

© AFP 2023 / STRYuan banknotes and US dollars are seen on a table in Yichang, central China's Hubei province on August 14, 2015
Yuan banknotes and US dollars are seen on a table in Yichang, central China's Hubei province on August 14, 2015 - Sputnik International
The yuan slid to its weakest level since May 2008 on Tuesday, stirring speculation over whether the Chinese government will tolerate a slide beyond the key level of 7 per US dollar.

There are growing expectations that the currency will soon test 7 per US dollar, a level unseen since the global financial crisis.

But although that level is a key psychological mark, it lacks great practical significance. We don't think the country should defend the psychological level at any cost.

The fall in the yuan has come as Sino-US trade friction intensifies, during which a moderate depreciation of the yuan is unavoidable and merely a reflection of supply and demand. If the yuan falls through the 7 per US dollar level, a market-driven depreciation will serve as an automatic economic stabilizer and benefit China's exports. Although currency depreciation will have a negative effect on the economy, the benefits will outweigh the costs of a moderate depreciation.

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So far this year, the Chinese authorities have intervened less in the yuan market than they did in 2015 when the currency posted a drastic depreciation, because panic has yet to peak in this round of depreciation. Most domestic traders still believe there is no basis for a massive yuan depreciation given strong economic fundamentals, a sustained trade surplus, the nation's sound fiscal position and ample foreign exchange reserves.

Even if the yuan falls below 7 per US dollar, it would have a limited psychological impact. Various factors are increasing depreciation expectations, but the situation is still controllable. China has yet to face a currency crisis in which the central bank has to intervene.

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Still, currency market participants are closely watching to see whether China's foreign exchange reserves will fall below $3 trillion. If the central bank uses the reserves to prop up the yuan, it will also have a psychological impact on the market.

A moderate depreciation of the yuan beyond 7 per US dollar isn't unacceptable. Amid the escalating trade friction with the US, the Chinese market is learning how to stay calm amid a market-driven depreciation of the yuan. The country will continue to deepen its market-oriented exchange rate reform. There is no need to safeguard the level of 7 per US dollar at any cost.

This article originally appeared on the Global Times website

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