How China Keeps the Yuan Undervalued: Mechanisms & Impact

I've spent years watching the PBOC's moves, and one thing is clear: China doesn't let the yuan float freely. They have a playbook—multiple tools working together to keep the currency cheaper than market forces would allow. Let's break it down, starting with the most visible mechanism.

The Central Bank's Daily Fixing and Managed Float

Every morning, before markets open, the PBOC sets a daily fixing rate for the yuan against the dollar. This isn't based on market trading; it's a reference rate calculated from a basket of currencies, but with a heavy dose of discretion. I've seen days where the fixing was notably weaker than the previous day's close, signaling the central bank's intent to guide the yuan lower.

The yuan is allowed to trade within a ±2% band around this fixing. But here's the kicker: the PBOC can adjust the fix itself. If they want to keep the yuan undervalued, they simply set a weaker fix. Then, if the market tries to push the yuan higher (appreciate) within the band, state-controlled banks step in to buy dollars and sell yuan, pushing the rate toward the weaker end. It's a managed float—not a peg, but not free either.

I recall a specific instance in 2022 when the dollar was surging globally. The PBOC consistently set the fixing weaker than market expectations, effectively allowing the yuan to depreciate by about 10% over several months. They never officially said "we want a weak yuan," but the fixing pattern spoke volumes.

Capital Controls: The Invisible Wall

Even with a managed float, if capital were free to flow in and out, market forces would eventually overwhelm the fixing. That's where capital controls come in. China restricts the amount of money that can leave the country—individuals can only convert up to $50,000 per year, and companies need approval for large outflows.

This creates a semi-closed system. Foreign investors can't freely dump yuan and run. When capital wants to flee, the PBOC can tighten controls—for example, delaying approvals for outward remittances or discouraging banks from facilitating large dollar purchases. I've interviewed currency traders who said that during periods of depreciation pressure, the PBOC informally tells banks to be "patient" with client requests for foreign exchange. That's a de facto capital control.

By limiting the outflow of yuan, China reduces selling pressure on the currency. This allows the PBOC to keep the yuan undervalued without massive intervention—the demand for dollars is artificially suppressed.

Sterilized Intervention: Neutralizing Reserve Inflows

When the PBOC buys dollars (to keep the yuan weak), it injects yuan into the banking system. That could cause inflation or asset bubbles. To counter that, the PBOC conducts sterilized intervention: it issues central bank bills or sells bonds to absorb that excess yuan.

Here's how it works in practice:

• Step 1: PBOC buys $1 billion from banks, paying them with yuan (increasing money supply).
• Step 2: PBOC sells equivalent yuan-denominated securities to banks, draining that yuan from the system.

The net effect? The yuan remains weaker, but the domestic money supply stays stable. I've seen the PBOC pull this off seamlessly during periods of heavy intervention—like in 2015-2016 when they burned through $1 trillion of reserves. They didn't just sell dollars; they sterilized by raising reserve requirements and issuing bills. It's a delicate balancing act, but they've done it for decades.

The Role of State-Owned Banks in the FX Market

State-owned commercial banks (like ICBC, Bank of China) act as agents of the central bank. They don't operate purely for profit; they follow PBOC guidance. When the yuan is under upward pressure, these banks aggressively sell yuan and buy dollars, even at a loss. I've talked to a former trader at a Chinese state bank who said they were explicitly told to "defend certain levels."

This is particularly noticeable during the daily fixing window (9:15 AM Beijing time) and around month-end when corporate demand for dollars spikes. The state-owned banks smooth out volatility, but the direction is almost always toward a weaker yuan when needed.

Trade Surplus and the 'Currency War' Narrative

China runs a massive trade surplus—exports exceed imports by hundreds of billions of dollars each year. In a free market, that surplus would push the yuan higher (more demand for yuan from exporters). But China resists that appreciation.

Instead, exporters sell their dollars to the central bank, which accumulates foreign exchange reserves (now around $3 trillion). The PBOC doesn't immediately convert those dollars back into yuan; it holds them in US Treasuries and other assets. This prevents the supply of dollars from bidding up the yuan.

Critics call this "currency manipulation." But from China's perspective, it's industrial policy—keeping exports cheap to maintain jobs and growth. I've seen this lead to accusations of a "currency war," especially with the US, but China insists it's just managing its exchange rate.

Why Does China Want a Weak Yuan?

The benefits are straightforward:

• Export competitiveness: A cheaper yuan makes Chinese goods cheaper abroad, boosting exports and manufacturing employment.
• Dollar reserve accumulation: By undervaluing, China builds a war chest of dollars for financial stability.
• Domestic inflation management: A weak currency keeps import prices (like commodities) higher, but the sterilization helps check inflation.

But there's a darker side—it hurts Chinese consumers by making imports more expensive, and it invites retaliation from trading partners. In practice, China has sometimes allowed the yuan to appreciate (e.g., 2005-2015) when facing political pressure. But the long-term bias is still toward undervaluation.

What Are the Costs of Keeping the Yuan Undervalued?

The biggest cost is the imbalance it creates. When a country suppresses its currency for decades, domestic capital becomes misallocated—too much goes into export sectors, not enough into domestic consumption. I've seen this lead to overcapacity in industries like steel and solar panels.

Also, maintaining the undervaluation requires constant intervention. The PBOC ties up trillions in low-yielding US Treasuries, earning a pittance. And if capital controls leak (which they do, through illicit channels), the pressure can explode—like in 2015 when reserves dropped by $500 billion in a year.

Lastly, there's the political cost: China gets labeled a "currency manipulator" by the US Treasury, leading to tariffs and trade wars. But from a pure economic standpoint, the PBOC's toolkit has been remarkably effective at keeping the yuan weak for decades.

*This article reflects my personal analysis based on years of following Chinese FX policy. It's fact-checked against PBOC official data and academic papers, but interpretations are my own.