Yuan volatility warned as Chinese leadership sends mixed signals on currency stability

PUBLISHED : Thursday, 10 March, 2016, 2:16pm
UPDATED : Thursday, 10 March, 2016, 2:16pm

The Chinese yuan has shown signs of stabilising since February as the depreciation pressure has eased in international markets. However, analysts warn of possible volatility as the leadership sent out signals at the National People’s Congress (NPC) that incoming data will be the key to determine the path of the yuan more than any prior commitment to keep it stable.

China’s forex reserves dropped by US$28.6 billion to around US$3.2 trillion in February, latest official statistics showed on Monday.

That is a significant improvement on the previous three months, which posted an average monthly decrease of US$98.2 billion, suggesting the depreciation pressure on offshore yuan has eased, said E Zhihuan, an economist at Bank of China Hong Kong.

“The yuan has gradually stabilised, with the onshore and offshore rates stronger versus the US dollar by 214 and 422 basis points respectively by the end of February, compared with a month earlier,” she said, attributing it largely to the pullback in the US dollar against other major currencies, especially the Japanese yen, as well as the reassuring remarks by Chinese government officials on yuan of late.

But analysts warn against complacence.

READ MORE: Yuan falls after mainland China reports worse than expected trade data

Alicia Garcia Herrero, an analyst for Natixis, draws attention to a statement on the exchange rate made by Premier Li Keqiang while addressing the NPC over the weekend.

Li made reference to the yuan exchange rate market mechanism, an expression previously used to refer the currency basket. But what might make investors quite “confused”, said Herrero in a recent research note, is that Li also reaffirmed that “RMB would be kept generally stable at an appropriate and balanced level”.

This new addition to the declared position on the future path of the currency at such a high level suggests that there is no firm commitment to a stable yuan, she said.

“In fact, Li preferred not to include a judgement on the statement as to whether the current level of the RMB is appropriate and balanced,” said Herrero.

Secondly, even if the current level were considered appropriate by the leadership, Li’s words make it very clear that the level of the yuan would need to be appropriate and balanced to remain stable.

“In other words, if incoming data continues to be weak, the current level of the RMB may no longer be appropriate or balanced,” she added.

Analysts from Deutsche Bank also said they believe the yuan may remain volatile in the short term.

“We believe that as the Chinese authorities allow market forces to play a greater role in determining the value of its currency, precisely at a time when the economy undergoes considerable adjustment and concern about the outlook is heightened, it is unlikely that the low currency volatility seen in the past decade will be revisited any time soon, ” the German investment bank said in a research report.

“Assuming that we are on the verge of departing from a regime where RMB has been essentially pegged to the USD, and the RMB will be more flexible in both directions, EM policy makers will have to take note of how this rise in RMB-driven volatility impacts their currencies,” the report added.