PBOC’s new yuan index may signal additional currency weakness

New yuan basket index unveiled Friday could pave the way for further currency devaluation, analysts say

PUBLISHED : Tuesday, 15 December, 2015, 2:02pm
UPDATED : Tuesday, 15 December, 2015, 2:02pm

A new index launched by the People’s Bank of China on Friday has stirred up speculation that the central bank has given the green light for further depreciation of the Chinese currency.

The PBOC late on Friday surprised traders by issuing a press statement unveiling a new index – The China Foreign Exchange Trade System (CFETS) exchange rate index. The new index will measure the yuan against a basket of currencies without revealing their exact make up.

In explaining the reason for the new index, the PBOC said: it “will guide market participants to shift their focus from the bilateral USD/RMB exchange rate to the effective exchange rate.”

The PBOC statement was unveiled as the yuan weakened to a fresh four-year low. It also precedes the US Federal Reserve’s policy board meeting for December, where the first interest rate hike in nearly nine years is widely expected to be announced at the conclusion Wednesday.

Analysts believe the latest move signals that the PBOC is about to guide to yuan onto a weaker footing.

“In our view, it is almost an official acknowledgment or a further confirmation that the CNY is no longer pegged to the US dollar but now to a basket of currencies,” Daiwa’s economist Kevin Lai said in a note distributed Monday.

He added that the new index provides a 26.4 per cent weighting to the US dollar, while the remainer is split among 12 other currencies.

“Potentially, the yuan could weaken significantly against the US dollar in the future, without moving the index too much,” Lai said.

In its statement, the PBOC noted that the yuan, when measured under the new index, has appreciated

2.93 per cent since the end of 2014.

Bank of America Merrill Lynch currency strategist Claudio Piorn said the new index could be a way for China to tamp down its currency in the event that a US rate hike this week triggers further US dollar appreciation.

“This would be particularly important if the Fed rate hike and the expectation of further hikes trigger significant dollar strengthening against developed market and emerging market currencies,”

Piorn said.

China is continuing to struggle with capital outflows, as monthly data shows the nation’s foreign exchange reserve contracting by $82.7 billion in November.

“Shifting the market’s onshore yuan focus to a basket of currencies is an attempt to manage market expectations away from onshore yuan weakness against the US dollar, which could trigger further outflows and negative spillovers into other Asian currencies,” Piorn said.

Jefferies equity analyst Venant Chiang calculated that the yuan is sinking to levels that could be dangerous for some highly leverage industries, such as property developers.

“Based on our estimate, a 5 per cent RMB devaluation will jeopardise major developers’ net profit by 21 per cent, net asset value by 6.5 per cent and net gearing will increase by 6 percentage points on average. Financial visibility could worsen alongside the dynamic currency market,” Chiang said.

Stephen Innes, senior trader at OANDA Asia Pacific said:“a stronger USD across the board would provide sufficient guidance for the market to interpret a higher USD/RMB, meaning the PBOC would be less likely to intervene in such instances.”

China’s currency ended weaker on Monday in both onshore and offshore markets.

HSBC said in a report that the PBOC new index does not mean China is going to formally target a currency basket like Singapore.

“The CFETS measure is just another CNY effective exchange rate for reference, much like the measures from the BIS and IMF indices,” the HSBC report said.

“We also believe that China’s ambitions for the RMB to be an important currency in the global monetary system means it eventually needs to move more independently of other major currencies,” the HSBC report said.

Meanwhile, Daiwa’s Lai said the recent weakness of the yuan was more than a coincidence.

“We believe the PBOC is taking advantage of thin pre-holiday market liquidity to drive the CNY lower (minimising negative reactions from the market).”