Strong words, subtle moves: how China fights to defend the yuan
Beijing wages war of words and widens regulation to safeguard value of its currency
China is opting for strong words and subtle trading tactics to gamble against the market over the yuan’s value in the first days of 2017, displaying a strong desire to avoid any sharp yuan weakening.
The offshore yuan exchange rate gained 1,600 basis points against the dollar on Wednesday and Thursday, as liquidity in the Hong Kong yuan market dried up, pushing the overnight yuan borrowing rate to 110 per cent on Thursday, the highest level ever.
China’s yuan mid-price in the onshore market marked the biggest gain on Friday since 2005 when China reformed its yuan exchange rate system.
The unusual market swings came after the People’s Bank of China made a series of statements in the past week to guard the yuan – at midnight last Wednesday it reminded the market that the yuan exchange rate hadn’t yet touched the key level of seven, it adjusted a basket of currencies to play down the dollar weighting, and China’s foreign exchange regulator explained new rules of individual foreign exchange purchases to smooth public concerns on New Year’s Eve, just to name a few.
When words proved insufficient, China’s monetary authorities intervened in the offshore market.
“The central bank is tightening liquidity supply in the offshore market ... to indirectly support the exchange rate,” said Zhou Hao, senior emerging market economist for Asia at Commerzbank.
Even though such an intervention comes at the dear price of crippling the offshore market and hurting the yuan’s global ambitions, it seems Beijing is willing to pay that price, Zhou said.
All these moves are part of Beijing’s challenging game to downplay expectations of further depreciation of the yuan against the dollar, and to stem continued capital outflow in 2017.
After falling nearly 7 per cent in 2016, the yuan is at risk of breaching the key seven level against the dollar. Major and ongoing intervention in the onshore and offshore markets has wiped out nearly US$1 trillion of the PBOC’s foreign exchange reserves since 2014, raising concerns that Beijing is running out of ammunition.
The reversal of yuan depreciation in Hong Kong, therefore, could mark the winning of a battle but not the war.
“The market knows that the central bank is intervening, but it is unclear how resolute it is,” said Steven Zhang, chief economist with Morgan Stanley’s China joint venture Huaxin Securities.
“The central bank should take every possible chance to publicly convey a clear message for a stable exchange rate,” Zhang said. “It cannot succeed just by saying something just once or twice.”
On the last day of 2016, the authorities announced additional requirements on personal foreign exchange purchasing, requiring buyers to declare the purpose for which they needed the cash and to promise not to use dollars for overseas property or securities investments, although Beijing did not cut its annual exchange ceiling of $50,000 for residents.
Individuals found “illegally” shifting money abroad would be punished severely, the State Administration of Foreign Exchange said. Meanwhile, the central bank insisted that the measures were not designed to tighten controls on the capital account but to “improve” China’s foreign exchange management system.
“We have an issue of expectations in China like what we expect the authorities to do,” said Louis Kuijs, the Hong-Kong based Asian head of Oxford Economics. “It would pay for policymakers to do more to move the whole thinking on the exchange rate away from bilateral rates.
“The central bank has started to do so, but it hasn’t gone really far enough,” he said.
“China’s policymakers have proven adverse to large moves in the exchange rate because it is bad for the real economy.”
Beijing’s wisdom will be tested this year on how to decide its priorities in yuan policy alongside an expected hardline approach from US president-elect Donald Trump against China, and the anticipated two to three increases of interest rates by the US Federal Reserve.
Kuijs wrote in a note on Wednesday that China’s central bank would “continue to walk a fine line” in 2017 to permit modest yuan depreciation on one hand, while curbing outflow on the other.
“We expect policymakers to continue with this approach rather than letting the yuan weaken more significantly, because of the impact on confidence in the currency domestically and unfavourable reception abroad, especially in Washington DC,” he wrote.