Yuan under depreciation pressure as onshore-offshore gap widens
Spread hits a monthly high of more than 390 basis points
The gap between the yuan’s onshore and offshore exchange rates widened this week after almost being bridged since late September, refuelling concerns that the mainland currency is coming under pressure to depreciate.
Onshore yuan (CNY) was trading steady at around 6.35 to the US dollar this week, guided by a People’s Bank of China’s daily fixing rate that barely changed over the five-day period.
However, offshore yuan (CNH) depreciated by 0.5 per cent this week, resulting in an enlarged gap with CNY. The spread hit a monthly high of more than 390 basis points on Friday.
Koon How Heng, senior currency strategist at Credit Suisse, said the market was speculating over fresh cuts to reserve requirement ratios (RRR) in the wake of weak economic data this week.
The People’s Bank of China met those expectations last night when it cut benchmark one-year interest rates by 25 basis points, in the sixth cut since November, and also lowered banks’ required reserve ratios by 50 basis points, enabling them to lend more to support the real economy.
“The widening gap is because of increased expectations that the People’s Bank of China will cut RRR soon,” Heng said. “The rise in [CNH] trading volume is clearly an indication of increased speculative activity. I believe this CNH versus CNY spot spread will narrow once speculative activity lessens.”
He added that a more concerning sign was CNH forwards trading weaker again. The one-year non-deliverable forwards, which reflect the exchange rate’s future outlook, was trading between 6.51 and 6.52 against the US dollar.
“This forward weakness of the CNY and CNH is clearly indicative of ongoing depreciation pressure,” Heng said.
The CNH market, although much smaller, has been viewed as a truer reflection of yuan’s value, owing to the absence of a trading band and constant People’s Bank of China intervention. When the yuan ultimately becomes fully convertible, the two exchange rates will have to converge into one. Therefore, a long-running, substantial gap between the two rates could be troublesome, and has been flagged by the International Monetary Fund as one of the issues that could potentially hinder the yuan’s inclusion in its special drawing rights currency basket.
After a surprise devaluation in August, the spread at one point widened to more than 1,000 basis points, as panic engulfed the market and investors dumped offshore yuan holdings. The gap narrowed in late September after authorities made repeated efforts to stabilise the market.
“There is unease about the economy, whether there will be fresh stimulus and its effectiveness, and whether at some point further currency depreciation is likely, so perhaps this period of stability is temporary,” said Sean Callow, an FX strategist at Westpac.
Mainland companies and individuals still prefer to hold US dollars rather than yuan, as shown by State Administration of Foreign Exchange data released this week.
Mainland banks sold a total of US$109 billion in foreign currencies in September, the bulk of them to their clients, implying strong demand for foreign currencies, said Xie Yaxuan, an economist at China Merchants Securities.
“Expectation for further depreciation still lingers. But I think it is up for debate if CNH is the real reflection of renminbi’s value,” Xie said. “PBOC’s market operation may be seen as intervention, whereas I see it as nurturing China’s fledging forex market.”