Technical Tuesdays

Want to find out where the Chinese yuan is going?

Want to find out where the Chinese yuan is going?

An export-oriented economy, like China, will usually keep its currency down to stay competitive on the global market.

But when the need for importing arises, the government may be tempted to increase the value of its local currency to minimize expenses.

This strategy becomes apparent when you take a closer look at China’s 5-year plans.

Between 2001 and 2005 for example, China focused on low-end manufacturing for export.

In order to boost exports, they focused on low-cost local resources, and did not invest in new technology.

During this time the Chinese yuan was pegged to the US dollar at a rate of USD/CNY = 8.28.

It was a period of tremendous economic growth.

Now in most cases, this would lead to an appreciating currency.

But in the case of China, the government took measure to keep the Chinese yuan low to support export growth.

Then, in China’s 5-year plan of 2006-2010, the focus shifted to high-end products.

For this, importing foreign equipment was necessary.

This prompted the Chinese government to increase the value of its local currency in 2006 and 2007.

However,  supporting exports remained vital, so China stopped appreciating the Chinese yuan after that.

Unfortunately, a low local currency is bad news for Chinese residents, as it makes imports more expensive. And with Chinese consumers only getting richer, the demand for imports only keeps increasing.

Then there are the businesses that start to outsource more and more.

The below graph shows China’s economic development over time.

When China’s GDP per capita grew between US$1,000 and US$2,000, the energy, materials and health sectors were booming.

But gradually financial services and consumer discretionary sectors took over to finally arrive at China’s current development level, with technology and telecommunications as leading sectors.

Over time, China’s gradual transition into services has pushed the Chinese yuan upwards.

 For the 5-year plan of 2016-2020, China intends to focus on high-end consumer and pharmaceutical products.

Again, this calls for more investment in foreign equipment and products. And sure enough, with the increase of foreign reserves, the local currency appreciated accordingly.

As soon as businesses have completed their investments, you can expect the Chinese yuan to go back down again.

Now, let’s check out the graph below.

Every increase in imports came along with an appreciation of the Chinese yuan. And when imports went down, such as what happened between 2014 to 2017, so did the Chinese yuan.

So, by carefully studying China’s 5-years plans, you can actually predict which way the Chinese yuan will go.

If the government is calling for more imports, you can bet that China’s currency will start to appreciate as a response.