China Can Loosen Monetary Policy Without Fretting Over Yuan Depreciation, Scholar Says

21 Jun 2024

China still has room to ease monetary policy to support its economic recovery without worrying too much about fallout from a depreciating yuan, a prominent Chinese finance scholar said.

“Allowing the currency to depreciate to some extent isn’t necessarily a bad thing, judging from the experience of Japan and other countries, as well as what has happened in China over the past few years,” said Zhang Liqing, director of the center for international finance studies at the Central University of Finance and Economics.

The Chinese economy has shown signs of improvement in recent months, but remains under pressure, with lingering uncertainties in the property market.

To support the economy, the government can implement more monetary easing and expansionary fiscal policy, as well as stronger structural reforms — moves that would put more pressure on the yuan, Zhang said last week in an interview with media outlets, including Caixin.

With the wide interest rate gap between China and the U.S., preventing yuan depreciation would mean raising interest rates or strengthening capital controls, but doing so could in turn hurt China’s growth prospects, he said.

As long as depreciation doesn’t trigger panic or lead to capital flight, the government could allow the yuan to weaken a bit, the professor said, adding that a rate of around 7.5 or 7.6 yuan to the U.S. dollar should be acceptable. The current rate is around 7.1.

Last month, the People’s Bank of China (PBOC) weakened its daily reference rate for the Chinese currency, a sign that it is willing to let the yuan depreciate further against the dollar as the country’s economy continues to suffer from poor sentiment and the U.S. has not started cutting interest rates.

But Zhang cautioned that the room for more monetary easing is limited considering China’s high macro leverage ratio.

Short and long term

The world’s second-largest economy reported expectation-beating growth in the first quarter of the year after struggling in 2023. Nearly three years of Covid-19 restrictions, which were scrapped in late 2022, and a prolonged property market slump have hurt businesses and sapped confidence in the economy.

In the near term, China’s economic recovery hinges to a great extent on how much of a rebound government policies can elicit in the property market, Zhang said.

China’s property market has remained in a slump since mid-2021 following a government campaign to limit developers’ borrowing. Policymakers have launched multiple waves of supportive policies, including recent moves to lower down-payment ratios and scrap a policy that set minimum rates on home mortgages nationally.

If the property market experiences a notable rebound after these support policies kick in, the economy will be well on its way to a relatively strong recovery, Zhang said. However, if these policies don’t have a clear effect or most cities don’t respond positively, there will still be considerable economic uncertainties.

During economic downturns, fiscal policies tend to have a more immediate impact than monetary policies, but the Chinese government needs to rethink how it deploys spending so it can be more efficient, according to Zhang. Expanding infrastructure investment can give GDP a quick boost, but can also create problems later, such as low usage or even idleness of new projects.

“Roads have been well-built in many big cities. So have high-speed railways, bridges and highways,” Zhang said. “But more money needs to be spent on building a stronger social security system, with better education, health care and other public services.”

Setting up a better social safety net, along with increasing households’ disposable income, can make people more willing to consume, he said.

Meanwhile, the government needs to lessen the burdens on small and midsize businesses by reducing their taxes and fees, the professor said.

In the long run, China needs to find new drivers for growth because infrastructure, real estate and exports — three areas that have long driven economic growth — are all showing signs of weakness, economists say. The country also needs to implement structural reforms and open up more parts of the economy, Zhang said.

As China’s population ages, the supply of both capital and labor might become scarce, so the country needs to improve its “total factor productivity,” a phrase that refers to the efficiency at which all inputs — such as labor, capital and technology — are used in production, according to Zhang.

External shocks

China’s economy is also facing uncertainties from overseas, from the upcoming U.S. election to tariff hikes on Chinese products such as electric vehicles.

These uncertainties will likely remain in the short term, Zhang said, adding that they could turn into an opportunity for China to accelerate the transformation of its economic structure.

The U.S. will likely uphold its bans on exporting certain technologies to China, and tariffs could become even more severe if Donald Trump gets reelected, Zhang said. While China could hit back with its own sanctions and tariffs, it could also further restructure its economy to shift reliance from exports to domestic demand.

For a big country like China, maintaining a trade deficit at a certain level isn’t necessarily a bad thing, he said. That would mean tapping international resources to develop the domestic economy and let people consume.

“Prioritizing a trade surplus could delay necessary adjustments to the country’s economic structure,” he said.