Yuan’s value and capital outflows expected to stabilise
Fed intentions and health of mainland economy key to analysts’ expectations
Fading fears of sharp yuan depreciation have helped end a recent string of contractions in mainland China’s foreign exchange reserves.
Analysts say the People’s Bank of China still has a great deal of firepower with which to manage FX market expectations and the yuan should stay broadly stable against the greenback this year unless market views of US Federal Reserve Board intentions change or a deteriorating economic situation on the mainland sparks a massive outflow of assets.
“The appreciation of the yuan against the US dollar over the past couple of months has shifted market expectations for the currency, with concerns about the possibility of a large-scale depreciation now receding and outflow pressures easing as a result,” Capital Economics’ China economist Julian Evans-Pritchard said in a recent research note.
After depreciating 1.3 per cent in January, the yuan stabilised in February and then appreciated 1.6 per cent against the US dollar last month.
The forward premium of offshore yuan against the greenback is also reflecting much improved sentiment.
As markets have calmed down, average daily USD/CNY trading volumes have also declined, easing to US$16 billion in February and US$19 billion in March after spiking at around US$30 billion to US$40 billion in early January, according to UBS estimates.
Favourable exchange rate movements and fading concerns over a sharp yuan devaluation had led to a surprise increase in the value of the mainland’s foreign exchange reserves, Evans-Pritchard said.
Those reserves rose last month for the first time since October to US$3.213 trillion, slightly above market estimates and up US$10.3 billion from February.
After adjusting for exchange rate fluctuations, Capital Economics estimated the People’s Bank of China sold around US$35 billion of foreign exchange in March, roughly the same as in February.
“Since we expect the current account surplus to have been around US$25 billion last month, this would imply net capital outflows of US$60 billion, up slightly from outflows of US$43 billion in February,” Evans-Pritchard said.
He said it was noteworthy that outflows did not jump back more significantly in March as banks and firms resumed business after February’s Lunar New Year holiday.
UBS analysts cited three factors contributing to reduced outflow pressures and improved FX market sentiment in recent weeks.
First of all, the US Fed’s more dovish stance and associated weakening of the US dollar had shored up market expectations that the mainland’s currency would not depreciate notably in the near future, said Wang Tao, lead author of the UBS report.
Secondly, a more explicit easing policy bias unveiled at this year’s National People’s Congress meeting and improvement in recent economic indicators, such as stronger-than-expected credit and fixed-asset-investment data, had also helped ease investor concerns about an “impending” hard landing for the mainland economy.
Last but not least, Wang said Beijing had tightened controls on cross-border capital flows to slow the pace of capital outflows, including stricter scrutiny of documentation supporting FX purchases for trade credit or investment projects, tighter monitoring of trade orders to clamp down on capital flows disguised as current account activities, and limiting the offshore use of Chinese debit cards for capital account purposes.
Analysts expect capital outflows and the yuan’s exchange rate to remain broadly stable this year.
Pressures could resurface at some point during the coming quarters if the US dollar strengthened again. However, “we don’t expect outflows to get out of hand,” said Evans-Pritchard, noting that the deleveraging of external debt, one of the main drivers of the outflows over the past year, could not continue at recent rates for more than a few quarters due to the limited stock of such debt.
“Unless a deeper economic crisis sparks a rush by Chinese firms and households to shift assets abroad, something we haven’t seen so far and that we believe to be unlikely, the PBOC should have plenty of firepower to keep the renminbi broadly stable in trade-weighted terms this year,” he said.
UBS analysts expect the mainland authorities will use a variety of policy tools to manage FX market expectations and deal with outflow pressures, in order to keep yuan depreciation “moderate” this year.
A weak US dollar, improved market sentiment, and better economic indicators should help reduce depreciation pressure for the yuan in the next few months, they said, while maintaining their USD/CNY forecast of 6.8 by the end of the year.