China's currency strengthened to a 30-month high against the U.S. dollar on Wednesday, driven by capital flows into the country, with its improving economic fundamentals expected to provide solid support.
The yuan's daily reference exchange rate set by the central bank appreciated to 6.2882 per dollar on Wednesday, the strongest since Aug 11, 2015. The onshore and offshore spot exchange rates both hit record highs on the same trading day, according to China Foreign Exchange Trade System data.
"Most of the yuan's strengthening against the U.S. dollar has been because of the general weakening in the greenback," said Louis Kuijs, head of Asia Economics at the Oxford Economics think tank, who raised the forecast of the yuan's exchange rate to 6.32 per dollar by the end of 2018 compared with 6.41 in his previous forecast.
The dollar index has fallen from about 103 in late 2016 to below 90. The yuan's exchange rate against the dollar has already climbed by 3.7 percent this year. Apart from a weakening dollar, increasing capital inflows as a result of rising foreign investment into the onshore capital market, especially the bond market, also has been behind the strengthening of the yuan. This indicates that investors' optimism toward the world's second-largest economy has improved and has made some headway in controlling debt, thanks to tighter financial regulation, they said.
According to data from the China Central Depository and Clearing Co, foreign investors increased their holdings of Chinese bonds by 6.5 percent last month to 1.04 trillion yuan ($166 billion).
"It seems that the yuan has become a resilient asset when the global capital market crumbled recently, as the Chinese economy has become much more stable and foreign investors' confidence has increased a lot," according to Tan Xiaofen, deputy dean of the School of Finance at Central University of Finance and Economics.
Zong Liang, Bank of China chief researcher, said that the increased capital inflows into China show that global investors' interest and confidence has strengthened, as top policymakers pledged to further open the domestic financial sector.
"A rush of capital inflows, however, should be prevented as it could fuel asset bubbles in Chinese real estate and capital markets and lead to financial risks," Zong warned.
Economists, however, do not expect nonstop appreciation of the yuan in the coming months, but rather fluctuations going up and down.
Pan Gongsheng, deputy governor of the People's Bank of China, the central bank, and also head of the State Administration of Foreign Exchange, wrote in a Chinese newspaper article published on Wednesday that "two-way" cross-border capital flows will be "normal" in the future and the total capital amount will "generally remain balanced", which economists said means there would be more ups and downs in the value of the yuan instead of one-way movement.
The monetary authority has emphasized keeping the foreign exchange policy "neutral", supporting legal capital inflows and outflows.
The People's Bank of China said in a statement after its annual work conference on Tuesday that it will ensure the yuan's stability at a "reasonable" level while to allow the market to play a more important role in determining the exchange rate of the currency.