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  • Dec 24, 2014
  • Updated: 7:54pm
BusinessBanking & Finance

Yuan rebound likely amid Beijing's bid to stem capital flight

Nomura forecasts a 3.5pc rebound in the currency as Beijing seeks to maintain stability

PUBLISHED : Wednesday, 09 April, 2014, 1:40am
UPDATED : Wednesday, 09 April, 2014, 1:40am

The yuan is poised to recover from declines that have made it Asia's worst-performing currency as Beijing seeks to prevent an exodus of capital that would threaten economic growth, according to the most accurate forecasters.

Nomura, which had the best estimates for the yuan over the past four quarters, predicts a 3.5 per cent advance to six per US dollar by the end of this year, matching the median projection of analysts in a survey. Japan's biggest brokerage said the People's Bank of China had guided the yuan's 2.5 per cent loss this year to help curb speculative bets on appreciation. Second-ranked Scotiabank forecast a year-end exchange rate of 5.98.

"The last thing they want to do is create an environment where the market sees the yuan is going to depreciate over the medium term," said Craig Chan, Nomura's head of currency strategy for Asia ex-Japan. "Capital flight could be very large and destabilising for the domestic market."

The mainland is trying to ward off speculators as controls on the exchange rate and borrowing costs are loosened in a shift towards a more market-based economy. The yuan has strengthened 33 per cent since a US dollar peg ended in July 2005 and expectations of one-way moves in the currency spurred bets on continued gains.

The reversal in the first quarter led to losses on offshore yuan structured products known as target redemption forwards. Morgan Stanley estimated last month that there were about US$150 billion of the contracts outstanding, held mainly by mainland companies, and these were losing about US$3.5 billion at an exchange rate of 6.20 per dollar. A slide to 6.38 would increase the losses to US$7.5 billion, the US bank said.

The currency closed at 6.2123 in Shanghai on Friday, the last day of trading before a holiday on Monday, according to China Foreign Exchange Trading System prices.

The central bank reiterated last week that it planned to keep the yuan "basically stable", saying it would closely monitor capital flows. It doubled the currency's permitted divergence from a daily reference rate to 2 per cent on March 17 and has since cut the fixing by 0.3 per cent. The spot rate was 0.9 per cent weaker than the reference rate on Friday.

"The most significant part of the move is done and 6.30 isn't on the cards in my view," said Sacha Tihanyi, senior currency strategist at Scotiabank in Hong Kong. "Fundamentally, China's capital account is still going to be in surplus, unless we see a significant amount of hot money outflows."

The yuan has had greater price swings this year after the central bank said it would allow more two-way fluctuations. One-month implied volatility, a gauge of expected exchange-rate moves used to price options, rose 27 basis points to 2.12 per cent on Monday. It touched 2.75 per cent on March 17.

"Things are no longer as stable as before," Tihanyi said. "There is more volatility and upside for the dollar versus the yuan."


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A similar argument is presented in the following Chinese article publlished in the People's Daily:
Recent economic statistics show that China's economy has been weakening.
China's monetary policy should now be relaxed to cope with this problem.
But the whole world places her bet on yuan's continued (massive) revaluation.
So hot money keeps on flowing into China, legally or illegally,
forcing the PBOC to keep on sterilizing the capital inflow,
maintaining a relatively high RRR,
and to use positive repo to reduce the market money supply.
How can more relaxed monetary policy be practised in China in this scenario?
Now think of it this way:
Continued yuan devaluation means there will be capital flight out of China,
thereby enabling the PBOC to relax her monetary policy (to maintain the market money supply),
to the benefit of the Chinese businesses (lower cost to renew their loans or obtain new loans), China's stock market, Chinese consumers (through stock-market's wealth effect),
and the US and other foreign countries (through greater Chinese demand for their imports).
Which means once again the yuan should devaluate, not revaluate, in the foreseeable future.
(Chinese readers: ****money18.on.cc/econ/econ_comment_content.html?type=2&cat=econ&aid=20140409fhta01&subsect=comment&adate=20140409)
While Diana Choyleva may think otherwise, China should still maintain her dam of capital control more intact at present.
(‘Chinese savers can scorch the world’ by Martin Wolf
What Beijing needs to do right now, is to solve the problem of zombie enterprises (and hence the problem of excess capacities, bad loans, and their inefficient occupying of the banks’ valuable new loans denied to the more efficient SMEs),
to allow them to dissolve,
or greatly downsize their scale of production,
or allow some of them to be acquired by more efficient private capital,
or through mergers and acquisitions,
or greatly devalue the yuan to help reinvigorate some of the zombies back into humans.
To solve the 2008 banking crisis, the US needs 3 rounds of QEs to absorb the private debts and turn them into public debts, thereby turning the Federal Reserve into a ‘bad’ bank.
In China, at the end of the day, to solve the problem of massive local government and SOE accumulated bad loans,
Beijing may not be able to avoid turning the PBOC into a bad bank also.
According to Choyleva, this just means a “modest” gross debt of 110 percent of GDP (which I think can easily be accommodated through the issuance of government treasuries).

Keeping on revaluing the yuan will make the above problems (much) worse, leading to more and more debt burden and a whole set of zombie enterprises in China, reminiscent of those prevailing in last-two-decade Japan.
The potential problem of capital flight out of China can be easily accommodated by relaxing the country’s monetary policy (say, lowering the RRR).
China’s excess saving is already large enough (too large actually) to finance her investment needs --- those hot money only serves to undermine China’s dam of capital control (thereby hindering her independent manipulation of interest and exchange rate to her advantage, according to the impossible trinity) and keeps on feeding the country’s precarious Ponzi-scheme-like shadow banking and property sectors.
Beijing should especially beware the Japanese bankers, as Julius Caesar should beware the Ides of March.
Reading the morning post every day, sometimes I can’t really believe my eyes.
Nomura, Japan’s biggest brokerage, the “most accurate forecaster”, ‘predicts a 3.5 per cent advance to six per US dollar by the end of this year’.
I can’t tell apart whether those investment bankers are really giving a good suggestion to China, or are just intending their own gains (or rather, reducing their own massive losses).
According to the article recently published by Diana Choyleva, a China expert, in the Financial Times,
‘Lombard Street Research estimates the renminbi is between 15 and 25 per cent above fair value. Overvaluation has already hurt corporate profits, which have been flat for two years.’
‘… bank lending to companies is being used to pay interest on old loans rather than for new productive activity.’


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