So, at the present, stabilizing the RMB exchange rate not only requires comprehensively striking back the speculation of short-selling the rate but, more importantly, reversing the expectation of the RMB depreciation and managing the expectation well. Otherwise, the speculation of short-selling the RMB in the offshore market will continue. The substitution of a new exchange rate index for the old exchange rate index does not mean that the RMB will not depreciate, because the international market does not accept the index at all.

The RMB exchange rate should be anchored to the US dollar exchange rate, for instance, 1 dollar in exchange for 6.4 or 6.8 RMB. When the US dollar enters the rate-hike cycle, if the RMB is anchored to a certain dollar rate, then the dollar appreciation will not cause the Chinese currency to depreciate. It will then improve the acceptability of the RMB in the international market and promote RMB internationalization. An obviously stable RMB exchange rate will not only stop the capital outflow but, more importantly, will reverse the expectation of the RMB depreciation and the international speculation of short-selling the RMB will get out of the market. This effect will be more obvious if the RMB appreciates slightly.

Stabilizing the RMB not only needs an anchor: China’s central bank should also make a clear RMB exchange rate policy. Especially now, China’s central bank should not have too much discretion. Addressing the flexibility of the RMB exchange rate may result in the loss of market credibility. The current strong expectation of the RMB depreciation is caused by the low credibility of the government exchange rate policy and the foreign and domestic markets’ lack of faith in the Chinese government. When counterattacking the foreign speculation of the RMB exchange rate, China’s central bank should also increase the cost of currency speculation through administration. For example, China’s central bank has recently carried out a normal reserve requirement policy on the deposits by overseas financial institutions inside China.

When the Chinese government gives a very clear policy on the RMB exchange rate, the market will have a clear expectation of the RMB exchange rate. In addition, the act of increasing the cost of international speculation through administration by China’s central bank will possibly stabilize the RMB exchange rate. Thus, even a slight RMB depreciation in the short term will not create much depreciation pressure on the RMB. From a medium- and-long-term perspective, with China’s economic restructuring improving and China’s giant economic status established, RMB appreciation is still more likely than depreciation. The prospect of RMB depreciation basically depends on China’s central bank’s judgment on the current market situation and what policies it implements. But that is uncertain now.

The author is a research fellow with Institute of Finance and Banking of the Chinese Academy of Social Sciences.

This post was first published at Chinausfocus.com. To see the original version please visit: http://www.chinausfocus.com/finance-economy/does-the-prospect-of-rmb-depreciation-depend-on-what-chinas-central-bank-wants/