Government should make due preparations to deal with the betting by some hedge funds on the yuan's depreciation

The recent decline of the yuan's exchange rate against the US dollar, together with the negative growth of China's funds outstanding for foreign exchange, has sparked market concerns over the "retreat" of international capital from the country.

However, further evidence is needed before jumping to the conclusion that "hot money" is accelerating its exit from China. Whether the decline of the country's funds outstanding for foreign exchange is caused by the exit of foreign capital or by the outflow of domestic capital is yet to be confirmed.

The depreciation of the yuan against the US dollar does not mean the fundamental reversal of its exchange rate or its full depreciation against the greenback following the appreciating tendency in the years since China launched reforms of the yuan's exchange rate. Due to the lack of its free conversion to other currencies, setting a reasonable equilibrium price for the yuan remains a particularly challenging task for the Chinese government, especially under the US dollar-led international monetary system. But it will be determined to maintain the stability of the yuan's exchange rate to protect the country's national interests.

In the context of the gloomy international economic prospects, China's economic downturn and its increased risks in the time ahead, some international investors are pessimistic about China's prospects. But whether China's economic development will be according to these expectations remains to be seen. It is reminiscent of the prophesy of "China's economic collapse" following the eruption of the Asian financial crisis in 1997. However, there is no escaping the fact that China experienced remarkable economic prosperity after that crisis rather than a collapse.

In the face of the growing pessimism over China's economy and its currency among international investors and hedge funds, the Chinese government should make an in-depth study on the reasons behind this pessimism and the potential actions that might arise from it and then make corresponding adjustments to the country's economic policies, so as to build up its economic resilience. The government should also make due preparations and take effective countermeasures to deal with the betting of some hedge funds on the yuan's depreciation. Only by so doing, can China maintain the stability of the yuan's exchange rate and bring about its long-anticipated exchange rate formation mechanism.

The negative growth of China's funds outstanding for foreign exchange in recent months has in part been caused by a decline in its trade surplus as the result of its decelerating export growth momentum and a decline in its inflowing foreign direct investment. But at a time when the global market remains extremely uncertain and risky and when China's economy is outperforming the rest of the world, any risks in China's market will be lower than those in the international market. Under these circumstances, international capital that has gained a footing in China is unlikely to choose to leave the country and put itself at greater risk elsewhere.

The recent decline of the yuan against the US dollar will facilitate China's efforts to reduce its controversial trade surplus and attain its policy target of striking a balance between exports and imports, while also helping to ease the pressures caused by its snowballing foreign reserves.

Nevertheless, the Chinese government should keep a close eye on the changed flows of international capital inside its territory and strengthen monitoring over "hot money". It should also remain highly vigilant of the potential effects on its monetary policies of the negative growth of the country's funds outstanding for foreign exchange. Despite a recent decline against the US dollar, the yuan is still within the range of appreciation and thus we should not over-interpret its downward tendency for the time being.

Instead of focusing on the retreat of foreign capital the government should pay special attention to the possible accelerated outflow of homegrown funds, something that is expected to have larger repercussions for domestic monetary policy.

The author is a researcher with the Institute of Finance and Banking, affiliated to the Chinese Academy of Social Sciences.