China Should Let Yuan Float to Avoid Slump, Ex-PBOC Adviser Says

What Is the PBOC's Strategy for the Yuan?
  • Set wide fluctuation band to avert market panic: Yu Yongding
  • PBOC should reinforce market-oriented reform plans, he says

Yu Yongding, a former adviser to the People’s Bank of China, has a bold idea to stem the yuan’s slump: Let it float.

QuickTake The People’s Currency

Policy makers should stop intervening in the currency market and preserve foreign reserves, Yu, a former academic member of the central bank’s monetary policy committee, wrote on Wednesday in an opinion piece on Project Syndicate, a website. In transitioning to the new regime, the PBOC should target the yuan against a basket of currencies within a band of 7.5 percent or even 15 percent, allowing market forces to determine the value of the exchange rate within the range, Yu said.

Under such a regime, investors might start purchasing yuan before the exchange rate reaches the limit of the trading band if they think that the currency has fallen enough to reflect economic fundamentals, he said. In the meantime, the government should implement existing capital controls “much more strictly” to limit outflows, Yu added.

“China is still running a large current-account surplus and a long-term capital-account surplus, and it has not fully liberalized its capital account,” Yu wrote. “So the chances are good that the yuan would not fall too far or for too long.”

Currency Defense

The yuan has weakened about 6 percent against the dollar over the past six months as the economy slowed and capital outflows mounted. The decline prompted the central bank to spend a record $513 billion in foreign reserves last year to shore up the currency.

Regulators have also tightened capital controls, reversing years of easing that had allowed the yuan to secure a global reserve status. To anchor investor expectations, the Chinese authorities have stressed that it aims to keep the yuan stable against a basket of currencies, breaking its tie to the rising dollar. Under the current system, the PBOC sets the yuan central parity rate against the dollar on a daily basis with a trading band of 2 percent up or down. 

Yu’s comments echoed those of other economists who have been advocating for a more flexible exchange rate. The central bank must give up the yuan’s peg against the dollar to avert more damaging rounds of depreciation, Li Daokui, a professor at Tsinghua University who also served as an adviser to the PBOC, said last week in an interview at the World Economic Forum in Davos, Switzerland.

Depleted Reserves

The current strategy to keep the yuan steady by burning billions of dollars in reserves did little to damp investor expectations for further weakening, according to Yu. The PBOC may soon deplete the country’s $3.3 trillion of reserves if it continues to defend the currency in this manner, and encourage more Chinese people to convert their savings to dollars, spurring additional capital outflows, he said.  

Even if the yuan goes through a double-digit depreciation under his proposed currency system, it won’t throw the country into a financial crisis because the currency mismatch at banks is small and inflation is just above 1 percent, Yu said.

Yu has called for more flexibility to boost the yuan’s global usage before. “A flexible exchange rate will give greater impetus to China’s economic readjustment and growth paradigm shift,” he said in an interview last November.

At a forum this week, Yu, who served as a member of the Advisory Committee of National Planning of the Commission of National Development and Reform, proposed economic stimulus similar in size to the 4 trillion yuan ($608 billion) package in 2008 to boost growth. The expenditure seven years ago helped cushion the impact from the global financial crisis, but also led to a surge in lending to wasteful projects.

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