Beijing, 12 December 2024 – In a new proposal aimed at boosting domestic monetary policy flexibility, the China Finance 40 Forum, a prominent think tank comprising senior Chinese financial experts and regulatory officials, has recommended that China temporarily anchor the yuan to a basket of non-US dollar currencies, particularly the euro. The move is seen as a strategic response to the growing challenges posed by a strong US dollar and rising external uncertainties, including the potential for trade tariffs under a re-elected Donald Trump.
The proposal comes at a time when China’s policymakers are grappling with the dual challenge of stimulating domestic demand through looser monetary policies while also contending with the need to maintain a stable interest rate spread between the yuan and the US dollar. With increasing external risks—particularly the strength of the US dollar and looming tariff threats—the Forum argues that anchoring the yuan to a broader currency basket would provide “greater flexibility” against the dollar, which has traditionally dominated China’s foreign exchange policy.
Greater Flexibility for Domestic Policies
The Forum emphasized that such a shift would allow the yuan’s exchange rate to be freed from tight fluctuation bands, thus enabling it to better reflect changes in both domestic and international economic conditions. This would, in turn, create more room for adjustments in China’s domestic monetary policy, which is increasingly important as the country seeks to revive its sluggish domestic demand.
“This approach would allow the yuan to adapt more fluidly to the complex economic landscape, providing policymakers with greater tools to manage both internal and external pressures,” the Forum explained in a statement.
The recommendation comes amid mounting pressures on the yuan, with the currency experiencing significant depreciation in recent months. As reported, the offshore yuan rate recently fell to around 7.3 per US dollar, driven by market expectations of a stronger US dollar policy under Trump’s second presidential term.
The Yuan’s Stability Amid Pressures
Despite these pressures, Financial News, a publication under the supervision of the People’s Bank of China (PBOC), maintained that the yuan has a “solid foundation” to remain stable in the near term, noting expectations for the currency to either stabilize or strengthen towards the end of the year. The PBOC’s recent decision to set the yuan’s midpoint rate at 7.1854 per US dollar further signals efforts to stabilize the currency.
However, the long-term outlook remains uncertain, particularly with the anticipated re-election of Donald Trump and the potential for aggressive tariff policies that could further weaken the yuan. In response to this, the Forum stressed that aligning the yuan with a broader basket of currencies, particularly the euro, could provide greater flexibility and shield China from external shocks, especially the challenges posed by a dominant US dollar.
Historical Context and Policy Shifts
Historically, China shifted from pegging the yuan exclusively to the US dollar to a basket of currencies in 2005, though the US dollar has remained the primary reference point due to its central role in global trade and finance. In recent years, however, the yuan has depreciated against the dollar as China has prioritized domestic economic needs over currency stability. In 2017, China was forced to intervene in the foreign exchange market to defend the psychological threshold of 7 yuan per US dollar.
The upcoming central economic work conference, which is expected to set the policy direction for the coming year, will likely address the issue of yuan policy. The current official stance focuses on maintaining the currency’s “basic stability” at a reasonable equilibrium level. Policymakers are likely to explore further adjustments to monetary policy to support China’s slowing economy and domestic demand.
Policy Shifts in Light of External Pressures
As part of the broader economic strategy, China’s Politburo recently pledged to adopt a “moderately loose” monetary policy, signaling a shift in tone towards more proactive fiscal measures. This shift includes a focus on “unconventional” countercyclical adjustments aimed at stimulating domestic demand. The China Finance 40 Forum advocates for aggressive measures, calling for “strong rate cuts” and the reduction of real interest rates to support economic recovery.
In addition, the think tank suggested lowering the rates on structural monetary tools—such as relending and special lending facilities—below policy interest rates, deeming them more effective than traditional tools like reserve requirement ratio reductions in boosting demand.
Looking Ahead: A Delicate Balancing Act
As China navigates the delicate balance between external risks and the need for effective domestic economic management, the proposal to anchor the yuan to a basket of non-US dollar currencies offers a novel solution to enhance flexibility. While challenges remain, including potential trade tariffs and the strength of the US dollar, the Forum’s recommendations highlight the growing importance of a more adaptable monetary policy framework that can respond to the evolving global and domestic economic landscape.
As China prepares to navigate these complex challenges, the coming months will likely see further adjustments to its currency policy, with the goal of ensuring stability while fostering economic recovery in the face of rising external pressures.
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