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China’s central bank likely to usher in more currency depreciation after Lunar New Year

Persistent capital outflows among factors weighing on yuan

PUBLISHED : Friday, 05 February, 2016, 11:55am
UPDATED : Friday, 05 February, 2016, 11:55am

While everyone is pointing fingers at the People’s Bank of China, they should realise it is not the US Federal Reserve, analysts say.

Pressure is lingering for more depreciation of the yuan and China’s central bank is likely to make another attempt at devaluation after the Lunar New Year, following earlier ones in August and last month, analysts said.

Offshore yuan fell to a three-week low of 6.6203 against the US dollar on Monday, after Japan took global investors by surprise by announcing on Friday it would cut interest rates below zero, and dropped further to 6.6423 on Wednesday morning.

In mid-January, the PBOC lifted the offshore yuan from a five-year low of 6.7128 and since then has been sending “stable” signals. In the first two weeks of the year, the central bank had set the yuan’s daily guiding mid-price weaker, but the move sparked wild expectations of yuan devaluation, accompanied by panicked capital outflow. The same thing happened after August 11, when it set the fixing 2 per cent weaker.

“Beijing may have been testing the water. It is unlikely that China will adopt a one-off devaluation,” said Aidan Yao, senior emerging Asia economist of AXA Investment Managers. “It seems more inclined to do it step by step – move downward a bit and observe the market reaction, and then decide what next.”

It is unlikely that China will adopt a one-off devaluation
Aidan Yao, AXA Investment Managers

However, he said, the reaction to the moves in August and January showed the market tended to interpret the active devaluation of the yuan as a hard-landing signal for China. That was something Beijing could not accept and that’s why it intervened, he said.

“If the global markets become receptive to yuan weakness as a natural part of China’s economic rebalancing, then the Chinese authorities would take the opportunity and allow a faster depreciation of the yuan,” Yao said.

Analysts said the chances of the yuan staying at its current level for long were slim. China’s economy is slowing down, along with the rest of the world.

Aggressive easing from Japan has weakened the yen and is likely to prompt other central banks, including the European Central Bank, to follow suit, putting more pressure on the yuan.

“The key point is that China has been subsidising its trading partners with an overvalued currency in recent years, and the PBOC will ask why they have to continue the situation now,” said Kay Van Petersen, Saxo Capital Markets’ Asia macro strategist. “Devalue the yuan would correct the currency which has been artificially held high. Letting it go naturally is in line with the yuan’s internationalisation agenda ... it would be an easy way out for the PBOC.”

But there were too many Communist Party members and too many vested interests sending conflicting information and signals about China’s currency market in recent months, indicating the PBOC might not be the one to make the decision, he added.

“When everyone is finger pointing at the PBOC, they should understand it is not the Fed,” he said.

At a meeting of central bankers at Ankara in September, PBOC governor Zhou Xiaochuan said China would give the market a bigger say in deciding the value of the yuan.

But since then he has not provided any explanation of the central bank’s stance on the yuan, or January’s government intervention in the offshore market. Leading financial figures, including International Monetary Fund head Christine Lagarde and former Fed chairman Ben Bernanke, have singled out China’s poor communication as a source of unnecessary market turmoil.

Yao said that even with the depreciation in recent months, the yuan was still 10 per cent overvalued.

“When China’s high-ranking officials, including Premier Li Keqiang reiterated ‘there is no basis for continuous devaluation of the yuan’, they were referring to the basket constituted by the currencies of its major trading partners that the yuan is now pegged to, rather than the US dollar,” he said.

The PBOC introduced a China Foreign Exchange Trade System (CFETS) basket in mid December, and has been indicating the yuan is depegging from the US dollar in favour of a broader basket of currencies.

Yao said he expected the yuan to depreciate by 7 per cent against the US dollar by the end of this year, to just above seven to the greenback, as it gradually unwound the 10 per cent overvaluation.

KH Heng, a senior foreign exchange strategist at Credit Suisse Private Banking, said he expected onshore yuan would continue to see more weakness towards 7.00 against the US dollar by the end of the year, after “near-term stability” lost support.

Persistent capital outflows were draining China’s foreign reserves, he said in a report outlining factors weighing on the Chinese currency. Weakening currencies in other Asian and emerging economies were strangling China’s exports. Deteriorating manufacturing growth in the domestic market had companies craving more monetary easing.

Meanwhile, Credit Suisse warned valuations on China’s A-share market would be suppressed this year as the yuan became more volatile.

“We find the drop in valuation in equity markets is often accompanied by the increase in currency volatilities, based on the analysis of 12 emerging markets,” it said in a report released late last month. “A possible explanation might be investors demanding a premium for currency risk.”

yu.xie@scmp.com