(Yicai Global) Mar. 1 -- As overseas funds remain enthusiastic for Chinese yuan assets, and with demand for the US dollar in China falling significantly, the yuan is expected to remain strong against the dollar and become a new safe-haven currency, according to Lu Zhengwei, chief economist at Industrial Bank.

Since the second half of last year, the US dollar index has risen to 96 from 92, while the dollar-yuan exchange rate has slipped to nearly 6.3 from around 6.5, forming an obvious contrast and showing that the yuan has not depreciated with the dollar’s advance. That is related to the supply and demand of the two currencies, Lu said in an interview.

Unlike other emerging markets as risk assets, yuan assets have gradually shown a safe-haven asset attribute in recent years. In the face of Covid-19, the adjustment in US stocks, and the Ukraine conflict, foreign capital always seems to add yuan assets. At such times, it can be seen that the yuan exchange rate ticks higher, Lu noted.

The attraction of yuan assets is related to China’s effective control of Covid-19, relatively sound fundamentals, and the “de-dollarization” of some economies, he said. 

Russia’s foreign currency assets have continued to increase since the outbreak of the pandemic, with the fluctuations in value converging with the yuan exchange rate rather than the euro. The could only mean that Russia has continued to increase its holdings of yuan assets in the past two years, the economist said.

Falling Dollar Demand

Since the start of Covid-19, the demand for US dollars in China has fallen significantly, as the country’s imports have been weaker than exports mainly because of the impact of the outbreak on the global supply chain, resulting in less demand for US dollar purchases, Lu said.

Moreover, the trade deficit in services amid the pandemic has also shrunk significantly. For example, the demand for US dollars for overseas travel and study has plummeted.

Chinese mergers and acquisitions activity overseas is also declining, further curtailing demand for foreign exchange, mainly because some developed countries have tightened oversight of M&As by companies from other nations, according to Lu.

Finally, with Hong Kong stocks and US-listed Chinese stocks underperforming last year, domestic investors are less keen to invest in equity markets abroad. Domestic demand for overseas real estate also was affected by the pandemic.

The Year Ahead

This year, the US Federal Reserve is expected to hike interest rates a number of times, and global dollar liquidity will tighten, putting pressure on the yuan. But Lu said the yuan exchange rate will still show resilience if supply and demand remains stable.

In terms of demand, China’s borders are not yet fully open amid the pandemic, and the deficit in service trade will not widen significantly, he said. Overseas M&As and investment in foreign stocks will also remain sluggish. But as the global supply chain gradually recovers, the trade surplus in goods may gradually narrow.

On the supply side, the narrowing of the US-China spread after the US interest rate rises may affect foreign capital inflows into China, but the country’s anti-epidemic advantages as well as the “de-dollarization” of some economies are expected to offset the negative impact caused by the narrower spread, Lu said.

Editors: Dou Shicong, Peter Thomas