SARITA JOSHI

[Q.No. 30] China is one country which has the biggest Trade Surplus. Even then its currency has
depreciated in the recent period. How do you explain this phenomenon?

Ans: The Chinese economy was supposed to be a global star however; the reality is different. The Chinese
economy grew much less than expected, making it harder to reach growth target of 5% for 2023. It is because
China’s main growth engine in the past had been fueled by external demand. But in the recent time, Chinese
exports have fallen significantly but still China is in trade surplus. Therefore, despite having the biggest trade
surplus, some of the driving reasons causing yuan’s depreciation are listed below:

1. Changes in monetary policy: Changes in monetary policy by the People's Bank of China (PBOC),
China's central bank have affected the value of the yuan. The PBOC has been cutting rates while the U.S.
Federal Reserve has continued to raise them. It has resulted into large fixed-income capital outflows from
China. Foreign investors in Chinese equities have been more patient, as they were expecting a fiscal
stimulus. When they saw no sign of such stimulus, equity investors started to pack up and leave. It has led
to a further depreciation of the yuan.
2. Global economic conditions: The depreciation of China's currency is also influenced by broader global
economic conditions. Along with the interest differentials in the global market, the Indian market has been
growing significantly. Because of that investors are seen withdrawing their money from Chinese market
and investing in the Indian market. Factors such as interest rate differentials, inflation rates and market
volatility can all affect investor confidence in a country's currency and contribute to fluctuations in its
value relative to other currencies.
3. Trade war with the United States: The ongoing trade tensions and tariff escalations between China and
the United States have been a significant factor influencing the depreciation of the Chinese yuan. Since
2018, the two countries have engaged in tit-for-tat tariff implementations, leading to uncertainty and
disruptions in global trade. Due to prolonged geopolitical tensions, trade war and its potential impact on
China's export-dependent economy have contributed to market sentiment and depreciation pressures on
the yuan.
4. Trade Surplus Dynamics: While China has consistently maintained a trade surplus due to its strong
export-oriented economy, the composition of its trade surplus has changed over time. China's surplus has
been driven largely by exports of manufactured goods, but the country has increasingly shifted towards a
more balanced economy with a growing emphasis on domestic consumption and services. As a result, the
dynamics of China's trade surplus may not have as direct impact on its currency value as it used to.

Although China continues to run a surplus with the rest of the world, it is gradually becoming smaller than it
used to be. China’s large trade surplus hasn’t yet resulted in any increase in China’s foreign reserves either because
when a country sells more than it buys, it receives net payments from foreign buyers in its own currency. That
takes yuan out of the global market and reduces foreign holdings of yuan. Similarly, despite efforts by the Chinese
government to manage its currency, market forces play a significant role in determining exchange rates. Factors
such as supply and demand for the yuan in international markets, investor sentiment, and economic indicators
seems to have great influence on the depreciation of the yuan.