It’s time for China to let the renminbi appreciate sharply

THE renminbi is hugely undervalued. This is an impediment to tackling China’s enormous current account surplus and the leadership’s stated desire of boosting domestic demand. Instead of managing the currency tightly against the US dollar, it is high time the authorities promoted strong appreciation against the dollar and on a trade-weighted basis.

Gauging undervaluation

Prominent currency valuation models are based on current account positions. This summer, the International Monetary Fund’s (IMF) External Sector Report noted that China’s 2024 cyclically adjusted current account surplus was 2 per cent of gross domestic product, exceeding its norm by 1.2 percentage points of gross domestic product. On that basis, the IMF estimated renminbi undervaluation at 8.5 per cent.

In the financial institution’s October World Economic Outlook report, however, China’s 2025 current account surplus was revised up to 3.3 per cent of GDP. Applying the IMF’s elasticity estimate, that would suggest an undervaluation of around 18 per cent, assuming the estimate is broadly in line with the cyclically adjusted surplus.

The IMF’s current account estimates are based on Chinese balance-of-payments (BOP) data, which started to diverge significantly from China’s customs trade data after the country changed its BOP methodology in 2022. If one uses customs data (based on the previous methodology), then the current account surplus increases significantly.

Further, assuming that China’s income balance is flat, notwithstanding the large and rising net international investment surplus (thus discounting the increased income deficit China has reported since the pandemic), the current account surplus could be in the order of 5 per cent of GDP. Applying IMF’s elasticity estimate yields an undervaluation of roughly 30 per cent.

Other data points also highlight renminbi undervaluation. The Bank for International Settlements’ real broad effective exchange rate for China has fallen 17 per cent since late 2021, whereas the dollar and euro are both up some 7 per cent. The IMF also vividly makes this point.

While China’s currency has depreciated against the dollar since 2022, and even more against the euro, looking simply at the renminbi’s nominal value understates China’s increased export competitiveness.

Chinese domestic prices have been flat or falling since 2023 due to the country’s domestic doldrums while its trading partners experienced modest inflation. For example, US inflation is roughly eight percentage points higher over the period, implying a real renminbi competitiveness gain of a similar amount.

Is stability reinforcing “instability”?

Chinese authorities have long expressed a desire for currency “stability”, especially at times of global instability. During the Asian financial crisis in 1997, the renminbi was pegged against the dollar, a pattern largely repeated during the 2008 financial crisis.

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After the pandemic, China’s authorities again tightened the renminbi’s linkage to the dollar – largely keeping the currency’s central trading point (the fix) fixed to the dollar at around 7.1. They also reduced the effective size of the band around the renminbi, with onshore spot value of the currency effectively capped by the fix.

In other words, the renminbi has traded in a band set by the fix and the 2 per cent weak edge of the band, while the 2 per cent strong side of the formal band has not been used.

The “refix” of the fix was initially a response to intensified depreciation pressure on the renminbi in 2023.

However, in 2024 and 2025, the direction of pressure on the renminbi shifted. Foreign-asset accumulation by state banks resumed, and, apart from the month around “Liberation Day” – when the US raised tariffs on China to more than 100 per cent – the generally reliable foreign-exchange settlement data has pointed to foreign-currency buying by the state banks.

The Chinese authorities have multiple tools at their disposal to influence the renminbi’s value – moral persuasion and direct guidance to state-owned commercial banks – that go well beyond the standard tools of monetary policy, direct foreign-exchange market intervention and capital controls.

Over the last decade, the Chinese authorities held their reported foreign-exchange reserves constant – yet the renminbi continues to behave like a heavily managed, rather than freely floating, currency.

The effect of these policies has been to make state banks the key actors in China’s foreign-exchange market, and the foreign-asset position of the banks a more important measure of the direction of market pressure on the renminbi than the People’s Bank of China’s reported balance sheet.

Moreover, unlike more market-driven economies, China continues to have the ability to target the exchange rate directly – and treat currency policy separately from domestic monetary settings.

Chinese authorities run the risk of mistaking a broadly steady renminbi against the dollar as a sign of stability, when the real renminbi’s plummeting can be seen as a sign of instability.

Not only does a plunging real renminbi point to a lack of stability, but it also reinforces instability for the Chinese economy’s future. Though one might argue that an appreciating renminbi could unhelpfully add to deflationary pressures, a highly undervalued renminbi incentivises exports and disincentivises domestic demand.

In particular, a rising renminbi could boost real incomes, and thus consumption and services, especially if a more active fiscal policy were used as a reinforcing tool to underpin consumer demand, domestic activity and limit deflationary pressures.

The stay-the-course macroeconomic policy approach of the recent plenum, however, means that Chinese growth over the coming years will continue to rely on the existing state-led, investment-driven growth model with a strong focus on manufacturing investment and insufficient support for household demand.

That, in turn, will underpin continued large external surpluses and greater trade frictions with the rest of the world. Net exports have been contributing far too heavily to China’s recent growth, and a stay-the-course policy implies that China’s growth will continue to rely on its ability to draw demand away from its trading partners.

Further, many foreign-exchange market analysts believe the dollar will remain broadly steady or decline in the period ahead. Given the Chinese penchant for stability, that would imply limited prospects for real renminbi upside and a significant risk of a further weakening of the renminbi that will only reinforce massive surpluses.

The US and other countries have important roles to play in curbing the current protectionist trade winds now under way. But so does China. Its economy would be well served by significant renminbi appreciation, which would in turn help quell these very forces.

Brad Setser is the Whitney Shepardson senior fellow at the Council on Foreign Relations. Mark Sobel is US chair of the Official Monetary and Financial Institutions Forum (OMFIF). Both previously served at the US Treasury.