The People’s Bank of China: Caught in a policy bind amid the yuan’s decline

The People’s Bank of China (PBOC), China’s central bank, finds itself in a challenging and delicate position as it grapples with the declining value of the Chinese yuan. 

For years, Xi Jinping’s administration has aimed to elevate the yuan’s global status, positioning it as a potential challenger to the dominance of the US dollar in international trade and finance. 

However, the current situation has complicated these ambitions. 

The yuan’s ongoing depreciation is not just an economic issue but also a political one, undermining the goals set by the Chinese leadership. 

Donald Trump’s election has further complicated Beijing’s already challenging policy landscape. 

Even before Trump won the presidency, the PBOC was grappling with a difficult policy dilemma.

On one hand, China faced significant economic and financial challenges that required accommodative monetary measures, such as reducing interest rates and injecting liquidity into the financial system.

However, Trump’s pledge to impose higher tariffs on Chinese imports to the United States has added even more pressure on the PBOC. 

To date, China’s monetary policymakers have struggled to navigate these mounting pressures with clear resolve.

Yuan’s decline

In recent months, the yuan has faced a significant decline against the US dollar and other major currencies. 

In the summer of 2023, the yuan hit its lowest level against the dollar in over a decade, continuing to slide throughout 2024. 

The Chinese currency’s weakening is primarily due to a combination of factors, both internal and external, that have put immense pressure on its value. 

These include slowing economic growth in China, a complex real estate crisis, capital outflows, and global geopolitical tensions. 

For a currency whose global influence was once growing steadily, these developments have dealt a severe blow to China’s economic ambitions.

China’s leadership under Xi Jinping has made the internationalisation of the yuan a cornerstone of its global strategy. 

Over the years, the PBOC has taken various steps to gradually make the yuan more freely convertible and accepted in international markets. 

The yuan was even included in the International Monetary Fund’s Special Drawing Rights (SDR) basket in 2016, a recognition of its growing role in global finance. 

This was seen as a milestone in Xi Jinping’s broader vision to elevate China’s economic and geopolitical standing.

However, the current decline in the yuan’s value undermines those efforts. 

A weaker currency not only makes Chinese exports cheaper, which could be seen as beneficial for trade, but it also makes imports more expensive. 

The resulting inflationary pressures and the increased cost of living could erode domestic economic stability. 

Moreover, as global capital markets have increasingly moved toward de-dollarisation, the weakening yuan presents a paradox. 

On one hand, China wants to assert the yuan as a rival to the US dollar, but on the other, a depreciating yuan is less likely to attract international investors or central banks seeking a stable reserve currency.

PBOC’s Policy Bind

The PBOC’s current dilemma is rooted in the difficult trade-off between stabilising the yuan and pursuing broader economic objectives. 

On one hand, the central bank has limited options to curb the yuan’s decline without triggering a host of unintended consequences. 

To support the currency, the PBOC could intervene directly in the foreign exchange market, using China’s large foreign exchange reserves to buy yuan. 

However, this would deplete reserves and could be unsustainable in the long run.

The PBOC could also raise interest rates to attract foreign capital and increase demand for the yuan. 

But this comes with its own set of challenges. Higher interest rates could further slow down China’s already fragile economy, discouraging domestic consumption and investment. 

Moreover, higher rates could lead to an appreciation of the yuan, which would hurt Chinese exporters by making their goods more expensive on international markets.

Another option would be to loosen capital controls, allowing more foreign investment in China. 

This could help prop up the yuan in the short term, but it could also expose the economy to more volatility. 

In recent years, China has maintained tight control over capital flows to prevent large-scale outflows of money. 

Relaxing these controls could exacerbate the pressure on the yuan, as investors may look to move their money out of China in search of better returns elsewhere.

In addition to these internal challenges, the geopolitical environment also plays a crucial role in the yuan’s decline. 

The US and its allies have imposed sanctions and tariffs on Chinese goods in recent years, and tensions between China and the West have only escalated. 

These geopolitical risks have made foreign investors more cautious, further contributing to the yuan’s depreciation.

Impact on Xi’s ambitions

Xi Jinping’s goal of elevating the yuan’s status in global finance is in direct conflict with the current reality of the yuan’s decline. 

For years, China has pursued a strategy of internationalizing the yuan, seeking to increase its use in global trade and finance. 

This includes efforts to establish yuan-denominated financial markets and encourage the use of the currency in trade agreements, especially with countries involved in the Belt and Road Initiative (BRI).

However, the yuan’s declining value presents a major obstacle to this ambition. 

A weaker yuan makes it less attractive as a reserve currency for central banks and international investors. 

If the currency continues to lose value, countries may be less inclined to hold yuan in their foreign exchange reserves or settle trade deals in yuan. 

This is a critical setback for Xi Jinping’s vision of a world where the yuan competes with the US dollar for dominance in the global financial system.

Moreover, the PBOC’s handling of the yuan’s decline is also being closely scrutinised by other global powers. 

If China cannot maintain a stable currency, its ambitions of challenging the US dollar could remain out of reach, reinforcing the existing dominance of the dollar in international trade and finance.  This could further hinder China’s ability to exert its influence in global economic governance.