MNI INTERVIEW: Yuan Rally Further Saps Inflation - Guan Tao

China should avoid using the yuan’s significant appreciation against the U.S. dollar as a policy tool to rebalance its trade surplus but should instead take measures to boost domestic demand, a prominent Chinese economist and foreign exchange expert told MNI, downplaying prospects for further significant one-way gains in the currency.

The authorities’ exchange-rate policy objective for 2026 will remain the prevention of either excessive appreciation or depreciation, as this provides a stable monetary environment for the economy, said Guan Tao, global chief economist at BOC International.

This aligns with the emphasis on “maintaining basic stability” in the yuan exchange rate at last month’s Central Economic Work Conference, a phrase which Guan said refers to preserving two-way flexibility and guarding against overshooting, rather than defending any specific level.

The yuan’s move through 7.0 to the dollar in late December was within expectations and does not signal a one-way appreciation trend, he said, though strengthening expectations for further appreciation could prompt market participants to accelerate foreign-exchange settlement, further amplifying gains in the currency, he added. (See MNI: Yuan Strength To Break 7.0 In Early 2026 - Advisors)

The yuan’s real effective exchange rate index fell 3.2% and moved outside its fluctuation range of the past decade from January to November, while China’s trade surplus hit USD1.08 trillion, surpassing its historic peak.

But yuan appreciation should not become a policy tool for correcting external imbalances while the economy remains sluggish, according to Guan, as this would exacerbate domestic supply-demand imbalances and add further downward pressure to already-low inflation.

While foreign banks argue that the yuan is undervalued and have pointed to likely further appreciation, Guan noted that more than 70% of the REER depreciation was driven by low domestic inflation rather than nominal exchange-rate movements. Any undervaluation should be addressed by strengthening the economy rather than through directly engineering appreciation, he said.

DOLLAR LOSSES

Some Chinese investors holding U.S. dollar deposits are already facing losses, after the onshore spot yuan appreciated by 4.43% in 2025, exceeding the 4.26% interest rate on one-year deposits in U.S. currency in January. 

China’s private sector has undergone a historic shift from net external liabilities to net external assets, which means that sensitivity to yuan rallies has significantly increased, Guan pointed out. 

While factors supporting yuan strength include expectations for further Federal Reserve’s rate cuts, weaker long-term U.S. dollar credit, easing China-U.S. trade tensions and a recovery in domestic momentum, Guan said there is still substantial uncertainty around prospects for continuing appreciation of the Chinese currency. 

In an interview in April, Guan had anticipated that the yuan would remain resilient despite disputes with Washington, and said that Chinese exporters should reduce dollar holdings and diversify trade settlement currencies.  (See MNI INTERVIEW: Chinese Firms Should Hedge Dollar Risk-Guan Tao)

RESERVE CURRENCIES

While the dollar’s share of global foreign-exchange reserves has declined and gold’s share has risen, no single currency is likely to replace the greenback in the foreseeable future, said Guan, adding that most gold transactions remain denominated in and settled in dollars.

The Fed’s determination to defend its independence despite pressure from President Donald Trump to cut rates may also exceed expectations, he added. Against an uncertain economic backdrop, internal policy disagreements within the central bank could intensify, increasing dollar volatility.

The focus of global trade friction could also shift away from the U.S. towards tensions between other economies, potentially restoring some of the dollar’s safe-haven appeal, with China’s large trade surplus potentially making it a target, Guan said.

Ultimately, boosting domestic demand and narrowing the savings-investment gap are the fundamental solutions for achieving both internal and external balance, he said.