Why Beijing has put global plans for its currency on hold
Making yuan a global currency can wait. For now Beijing has prioritised stabilising the yuan over everything else, tightening controls over capital outflow to curb speculation that triggered sharp devaluation of the currency this month. But it has not closed the door to the global dream and investors just need to adapt to its new pace.
As capital outflow pressure piles up with the decoupling of monetary policies between China and the US, and expectation for a weaker yuan grows as economic growth slows to the lowest pace in 25 years, China is struggling to rebalance its pace of opening up its capital account, an irreversible commitment it has signed on to by joining the International Monetary Fund’s elite list of currencies in November.
“China is obviously not moving to a new regime in which suddenly everything becomes market-based. It’s not surprising that the government is managing the process. Managing the process means opening the door for a little while, and closing it, and opening again,” said Markus Schomer, chief economist at PineBridge Investments.
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According to KH Heng, senior forex strategist at Credit Suisse Private Banking, “It looks like the immediate priority of the Chinese authorities is to stem excessive capital outflow and one-sided speculative bets for yuan depreciation.”
“But I believe that over the long term, over a multi-year horizon, the objective is still internationalisation of the RMB. This is in line with recent efforts for more foreign central banks to trade in onshore foreign exchange market,” he said.
Doubts have been cast on China’s grand plan opening up its capital account after the People’s Bank of China (PBOC) unexpectedly pushed up the funding rates on the offshore yuan markets on January 12 and imposed the reserve ratio on foreign banks a week later.
Before that, the turmoil on China’s yuan market had battered offshore yuan – mainly traded on the free market in Hong Kong – to a five-year low as it plunged to 6.6964 against the US dollar on January 6.
PBOC data show commercial banks sold a net 629 billion yuan (US$95.61 billion) worth of foreign exchange in December, or nearly triple the amount the previous month, as capital outflows grew.
Meanwhile, as the central bank continues to fight off speculators, China’s foreign exchange reserves are bleeding. Reserves contracted by US$ 513 billion last year to US$3.33 trillion from a peak of US$3.99 trillion in June 2014.
The IMF approved the inclusion of the yuan as the fifth member of its Special Drawing Rights (SDR) currency basket in November, which is set to take effect this October. The PBOC had declared it would reduce intervention in the exchange rate and accelerate the full convertibility of the yuan after the decision.
Lu Wenjie, a strategist at UBS, said it seemed the PBOC is dealing with a new situation since joining the SDR and would step up management of the capital accounts “for a while”, but is unlikely to pull back too much. For instance, it is unlikely to scrap the annual quota of US$50,000 for individual Chinese nationals buying foreign currency.
“The market is trying to figure out what the bottom line of the central bank is. It could be the size of capital outflow or the stability of the exchange rate, or the independence of the exchange rate policies. But obviously, they cannot hold all of the three lines,” he said.
The opening of the capital markets essentially involves the reallocation of China’s investment capital, which will cause net capital outflow and further weaken the yuan, said Schomer at PineBridge.
“But China did choose a good time to make the move, because it would be much more complicated and damaging if they opened the door when the currency was undervalued…the minute you open the door the currency begins strengthening, and China will have to curb currency appreciation that would strangle exports.”
Other analysts also broadly argue it would be much more painful and the outflow would be much more aggressive if hot money flooded in when the currency was undervalued. China has avoided that situation.
“Right now, the biggest problem is the fear triggered by yuan’s valuation falling too much, which drives volatilities. But this is much easier for China to manage,” Schomer said.
But one thing that really is in great need for improvement is communication. Investors have been second-guessing the PBOC as the latter has stayed mum and unreachable for almost two weeks amid the sharp devaluation of the yuan since January until it suddenly launched a shock-and-awe attack on yuan short-sellers on January 12.
No senior officials have made any comment or taken questions from media until January 15, when Premier Li Keqiang made an official statement, saying “China has the ability to continue to maintain the yuan exchange rate basically stable at a reasonable and balanced standard”.
“China is obviously not used to communicate with the financial markets,” said Schomer.
“We go through the US Fed’s statement with extreme scrutiny, looking at where the commas are, at every single word. Everything the US does gets scrutinised under a microscope and China gets the same attention. It’s not that China should do the same. It just needs to develop its own style.”