• Sun
  • Sep 21, 2014
  • Updated: 5:09pm

Yuan suffers its biggest fall on record amid speculation over widening of trading band

Speculation over widening of the trading band is blamed, but analysts say central bank guided devaluation to temper expectations of investors

PUBLISHED : Saturday, 01 March, 2014, 12:03am
UPDATED : Saturday, 01 March, 2014, 4:47am

The yuan plunged to a 10-month low in its biggest daily fall on record yesterday.

It dropped 0.86 per cent to trade at 6.1808 against the US dollar, even after the People's Bank of China (PBOC) fixed the rate at 6.1214 yesterday morning.

It was the largest intra-day fall since China Foreign Exchange Trade System records started in 2007 and the biggest since the official and market exchange rates were unified in 1994.

The yuan ended the day at 6.1450, having lost 1.4 per cent in February - the biggest-ever monthly drop in the currency, according to Reuters.

Analysts said the fall was a response to speculation that the central bank would widen the yuan's trading band in the next few months.

This would have the effect of allowing greater volatility in the currency at a time when the world's second-largest economy was slowing.

Raymond Yeung, a senior economist at ANZ Bank, said the devaluation of the yuan was guided by the central bank, which had been setting a lower reference rate over the past few weeks.

He suggested the central bank "intended to tame expectations of a one-way rise in the yuan".

The yuan can trade as much as 1 per cent on either side of the reference rate set by the PBOC.

Mizuho Securities economist Shen Jianguang said the government-guided devaluation of the yuan would shake out investors drawn by the higher interest rates offered on the mainland. He said the prospect of higher interest rates had prompted inflows of hot money from players speculating on the yuan's unabated rise.

Industry insiders said a rising number of retail investors were using money borrowed in Hong Kong to buy yuan-denominated financial products across the border. Greater volatility in the yuan would therefore increase their investment risk.

DBS economist Nathan Chow agreed that the central bank's intervention reflected its desire to temper expectations of appreciation and counter hot money inflows as it prepares for the widening of the trading band.

A stronger yuan would also dampen China's export business, he added.

The wider trading band could be announced in the coming months after the National People's Congress and the Chinese People's Political Consultative Conference, which start in Beijing next week, Chow said.

Despite the possibility of greater volatility in the yuan exchange rate, expectations of an appreciation of the yuan against the dollar would remain unchanged, said Chow, estimating the yuan was likely to rise to 5.97 by the end of this year.


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If the capital inflow and the currency's revaluation mutually reinforce each other, does it mean that the currency has to keep on rising forever?
When will (and should) it stop?
And the capital flow through China’s border isn't a one-way street.
If there is massive capital flight out of China, say caused by the recent unexpected massive yuan devaluation, does it mean that the yuan then has to devalue even further against the US$?
What's low isn't low enough?
By the impossible trinity, under strict capital control, China is free to manipulate the yuan up or down against the US$, according to her own needs, irrespective of the size of her trade surplus or the direction of cross-border capital flow (which in principle should not be very large in size, except for those FDIs).
There is no causality between the trade surplus/capital inflow and the up-and-down movement of the currency’s exchange rate.

So many people (some of them professionals) keep on arguing that, despite the recent devaluation, the yuan will keep on revaluing against the US$ in the future, because of China’s persistent trade surplus and the capital inflow into the country.
This is bad economics indeed.
As I have said so many times here, not even a massive yuan revaluation (against the US$) will reduce China’s trade surplus to zero in the foreseeable future (as is so often argued by the US Congress).
The current account surplus is dictated by China’s own excess savings, which is structural in nature, and mainly caused by the financial repression.
From 2005 up till now, the yuan has revalued more than 30% against the US dollar, but China’s current account surplus is still positive at present.
After the Plaza Accord in 1985, the Japanese yen (and the German Deutsche Mark) appreciated greatly against the US$.
But Japan’s trade surplus kept on growing in the next few years after 1985.
Does it mean that the yuan still has to keep on revaluing, even when one yuan can be exchanged for US$6.1451 in the market, so long as China’s trade surplus remains positive?
Indeed China doesn’t need those capital inflows.
Even though her trade surplus as a share of GDP has declined in recent years, it’s still positive.
With the gradual recovery of the western countries it may become larger once again.
So China as a whole still has excess savings --- her domestic savings is already large enough to finance her domestic investment needs (some are wasteful already).
She just needs those useful FDIs (together with the sorely-needed technology transfer).
She doesn’t really need those RQFII money from Hong Kong and elsewhere, let alone the short-term speculative carry-trade hot money --- these monies are mostly borrowed by China’s local governments and property developers (thereby enabling the Ponzi game to go on).
So I don’t understand why the Hong Kong government wants to enlarge the daily HK$-yuan exchange quota.
Maybe our still-pro-big-business government wants to help the Hong Kong banks to earn more money.
Just like she wants to maintain the linked exchange rate mechanism to help the big businesses (the property developers and the banks) to earn more.
Last year HSBC earned more than 1/3 of her global pre-tax profit from Hong Kong --- a small city with only 7 million people.

Of course China always faces the threat of trade protectionism implemented by the other countries, especially by the US.
But China’s retaliation is also always a possibility.
What if the massive yuan devaluation triggers a massive capital flight out of China, propping up further the interest rates, popping the property market bubble, and derailing the shadow banking system (trust product markets)?
The Chinese banks can always come to the rescue.
The central bank can always ease its monetary policy and ask the banks to lend more to prevent the interest rates from going to the sky.
The liquidity is always there.
China's debt problem is chronic, not acute.
It can gradually be solved by developing her debt market (like the local governments' municipal bond and the corporate bond market).
Dai Muff
Manipulated. Don't trust it.
Now we also see clearly one disadvantage of a country’s having a currency as the world’s reserve currency.
One way for the US to recover from the recession and grow her economy is to increase her exports (and reduce her imports), through a depreciating US dollar against other currencies.
Instead, what’s happening is exactly what the US doesn’t want --- (competitive) devaluation of other currencies against the US dollar.
China will encounter the same problem when the yuan becomes one of the global reserve currencies in the future.
According to Diana Choyleva, Chinese people don't really buy a lot of imported goods ---yuan's revaluation benefits more the SOEs which have to import lots of raw materials and energy products.
Given an overvalued yuan, it's always faster for China to restore her external competitiveness by quickly devaluing her currency, instead of undergoing the painful and time-consuming internal devaluation, as in 1998-2003 Hong Kong and the present-day Euro-peripheral countries.
Given China's still-to-catch-up consumption and too-high-already investment, the only way to sustain her future growth rate (more than 7%) is to maintain a healthy amount of trade surplus.
Otherwise her unemployment rate may suddenly shoot up, because the SMEs has no need to retain the superfluous workers anymore --- the difficulty of rehiring them is no longer there.
This will threaten China's systemic stability.
Now it takes at least ten days for the yuan to devalue by 10% vis-a-vis the US dollar.
This 10% drop may not be too exaggerated if we consider the massive depreciation of the EM countries’ currencies and the Japanese yen against the US dollar.
Strangely, the Euro remains one of the strongest currencies in the world, given EU's relatively weak and Japan-like economy --- especially if European QE remains unenacted.
Unlike the periods 1997-1998 and 2007-2009, this time is really different for China --- she has to deleverage and reform her econmy while facing the possiblitiy of a (much) slower growth rate.
It's said that before the present devaluation, the yuan may be overvalued by 10 - 15%.
If China doesn't lower her currency, her external market share will further be stolen by other countries.
Inside a jungle, being a gentleman means being eaten alive in no time.
The present 1.4% drop in the exchange rate isn't big enough to 'shake out investors drawn by the higher interest rates offered on the mainland.'
Given the still-very-high interest rate differential between Hong Kong and China, and given the possibility of hedging, the carry trades are still very profitable.
Indeed the gradual devaluation of the yuan, dictated by the 1 per cent fluctuation on either side of the reference rate, creates a new profitable one-way bet, this time only in the reverse direction.
Lots of people have been doing this already. They just need to short the yuan.
Perhaps some well-informed people in China may have been doing just that as well.
Before the start of the yuan devaluation, I suspected that China might do so, considering the relatively strange phenomena that China had been importing a great amount of copper, iron ore and oil from the foreign countries in recent months.
Which shows that the present devaluation is well planned in advance.
Which also means that the yuan's drop may go to a greater extent and last a longer time than most people expect.


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