Yuan’s recent rally may be short-lived, despite thumbs up from IMF
Although the International Monetary Fund (IMF) has given a positive outlook for the yuan, economists and analysts say the currency will continue to depreciate, albeit modestly, over the remainder of the year.
The IMF said the yuan was broadly in line with its fundamentals in its annual external sector report released last week. Although it has been fluctuating greatly over the past couple of months,“the movement was not substantial enough to change its assessment,” the IMF said.
The yuan posted a rally against the US dollar last week, with onshore and offshore yuan both hitting their highest levels in four weeks.
Analysts said the rally was likely the result of the Chinese central bank’s guidance as it would like to see a stable yuan ahead of the G20 summit in September this year. The yuan is not yet fully convertible so the People’s Bank of China (PBOC) sets a reference point for the yuan each morning, with traders allowed to trade up to 2 per cent either side of the mid-point. Consequently, currency traders closely monitor the reference rate to see how the central bank wants to guide the market.
The PBOC raised yuan’s reference rate for the fifth consecutive day on Monday after the US posted weaker-than-expected GDP data and the Bank of Japan disappointed the market by holding interest rate unchanged.
However, not everybody is so positive about the yuan, which has depreciated more than 3 per cent this year against the greenback.
In terms of outlook, many analysts believe the downward pressure has not ended and the recent rebound will be short-lived, with the yuan likely to depreciate mildly in the second half of the year.
“I don’t think the rally could last. It’s more like a technical rebound,” said Songzuo Xiang, chief economist with Agricultural Bank of China, the country’s third-biggest lender.
“More likely it will weaken very mildly until the end of the year,” he added.
Qingming Zhao, chief economist with China Financial Futures Exchange, echoed the forecast of a weaker performance in the second half, saying the volatility of the yuan is expected to increase.
“Although the Federal Reserve didn’t indicate a near-term rate rise, it’s just a matter of time,” he said.
“It seems top Chinese officials think the yuan has been somewhat overvalued and are inclined to see a moderate depreciation.”
In February this year, PBOC governor Zhou Xiaochuan indicated that the yuan may need a “make up depreciation”, since it hadn’t seen significant weakening against the dollar after the US economy started to show signs of recovery in the wake of 2008-2009 financial crisis, whereas other major currencies depreciated significantly.
“No doubt, China still needs a cheaper yuan at the moment,” said Xiang.
China’s official manufacturing PMI came in at 49.9 in July, lower than 50 in the previous month, missing the market expectation of 50, according to data released by the National Bureau of Statistics on Monday.
In addition, the nation’s GDP grew by 6.7 per cent year on year in the second quarter, the same rate as the first quarter but with weaker underlying numbers. In particular, exports continued to drop, down by 4.8 per cent in June compared to a year earlier.
A depreciating yuan to stimulate exports is viewed by many as the key to boosting the softening economy.
Bank of America Merrill Lynch, Pacific Investment Management Co and Societe Generale also believe the PBOC is more likely to guide the currency lower than to prop it up, according to a Bloomberg report.
Some also believe that, since the sharp weakening of the yuan over the past couple of months hasn’t caused any market turmoil similar to what happened in January this year after the yuan plunged, that the Chinese government will be less nervous about depreciation.
While the market predicts the yuan will weaken further, the extent of the depreciation is expected to be mild and analysts believe any drastic movement is unlikely.
“It’s unlikely that the yuan will weaken below 6.85 yuan per US dollar by the end of the year,” said Zhao.
Xiang of Agricultural Bank of China added, “It will probably stabilise around 6.8 (per dollar) within this year. The depreciation by the end of the year would be within a 5 per cent range at most. “Any bigger depreciation may bring about challenges for the capital market,” he added.
Macquarie Capital also thinks onshore yuan would most likely end this year at 6.60-6.80 yuan per US dollar.
Bank of America Merrill Lynch also expects a 5 per cent depreciation by the end of this year, while Citibank thinks the yuan is likely to weaken to about 6.75 yuan against the dollar in the same period.
China International Capital Corp said overseas demand for the yuan is expected to increase after its official inclusion in the IMF’s SDR basket this October, which would provide some support for the currency, making any big depreciation unlikely. CICC also said the PBOC will try to avoid any substantial rise or decline in the yuan before the official SDR inclusion.