US Fed rate hike: how can China stem capital outflow and prop up the yuan?

As US central bank announces its sharpest rate increase in 22 years to address decades-high inflation, analysts speculate on how Beijing will try to soften the economic blow

People’s Bank of China has a number of tools at its disposal, and extent of intervention will play a role in whether GDP growth goals are achievable

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Some suspect that the yuan’s exchange rate could reach 7.0 against the US dollar this year, amid the US monetary policy tightening. Photo: Reuters

Published: 10:15pm, 5 May 2022Updated: 12:12am, 6 May 2022

One of the external headwinds that China’s economic policymakers have been warning about has materialised, with the US Federal Reserve announcing its sharpest interest-rate hike in more than two decades.

The Fed’s move on Wednesday – raising the benchmark interest rate by 50 basis points to a target rate range of between 0.75 and 1 per cent – was expected, and it will be followed by further tightening later this year.

But analysts warn that the central bank’s aggressive attempt to tame the highest inflation in 40 years will lure a large amount of capital back to the United States, exert depreciation pressure on the yuan and curtail Beijing’s monetary policy loosening – a key tool to help coronavirus-hit businesses and achieve the government’s annual economic growth target.

Unlike the Hong Kong Monetary Authority, which subsequently announced a 50-basis-point rise, the People’s Bank of China (PBOC) kept the rate unchanged when selling 10 billion yuan (US$1.5 billion) worth of reverse repo – a regular liquidity-injection tool – on Thursday morning, and lifted the daily yuan-US dollar midpoint 0.8 per cent higher.

Tan Yaling, head of the Beijing-based China Forex Investment Research Institute, said that an acceleration in capital outflows – the result of US Treasury bond yields surpassing those of Chinese bonds – could be partly offset if Beijing strengthens its regulation of the forex market and steps in to prevent excessive depreciation of China’s currency.

“The yuan is not a fully convertible currency,” she said. “Forex controls should be put in place when necessary. They are all for the sake of [financial] security.”

Overseas investors had already slashed their holdings of Chinese bonds and equities by 112.5 billion yuan in March, after selling 80.3 billion yuan worth a month earlier.

And after a net inflow of 1.9 billion yuan via the mainland-Hong Kong Stock Connect programme was reported in April, an additional 275 million yuan inflow was seen on Thursday, the first trading day of May following a five-day public holiday, according to data provided by Eastmoney.com.