image

Yuan

China’s three-trillion-dollar question: the yuan or forex reserves?

The central bank is rapidly depleting its foreign cash hoard to prop up the Chinese currency

PUBLISHED : Saturday, 07 January, 2017, 7:02am
UPDATED : Saturday, 07 January, 2017, 8:43am

President Xi Jinping will face a daunting task when he addresses global political and business elites at the World Economic Forum in Davos, Switzerland, later this month.

Xi must show the world that China has not lost control of its pursuit of a stable yuan and is also maintaining sufficient foreign exchange reserves.

For Xi, an ideal situation would be for the yuan to stay stronger than seven to the US dollar and the forex reserves to be above the key level of US$3 trillion.

The central bank will release the figure for the year-end foreign exchange reserves today. If the reserves shrank by more than US$51.5 billion in December, Beijing will find its stockpile below US$3 trillion for the first time since 2011. In November, the reserves fell by US$69.1 billion.

“At the moment, they are keen to both prevent the yuan from

being weaker than seven and the ­forex reserves from falling,” said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong.

It’s a delicate balance. If China wants to keep the yuan from falling too far, it has to intervene in the foreign exchange market.

China should let yuan fall, says the latest economist to join call for central bank to change tack

The central bank has been doing just that over the past two years, depleting the country’s ­forex reserves by nearly US$1 trillion since the peak in 2014.

But a growing number of economists are calling this approach unsustainable, saying ­Beijing’s key ammunition in defending the Chinese currency, its US dollars, will run out at some point, leaving the People’s Bank of China (PBOC) defenceless in the face of a falling ­yuan.

Both the value of the Chinese currency and the size of the reserves are seen as barometers of the country’s financial resilience.

As the yuan’s depreciation and a big fall in reserves roiled markets across the world last year, the Chinese delegation to Davos led by Vice-President Li Yuanchao sought to assure attendees that the Chinese economy and financial system were fine.

The central bank’s sensitivity to the “seven” level became clear last month when it published a late-night notice to remind the public that the yuan had not yet reached seven against the US dollar. That reminder came after some media outlets incorrectly reported that the key psychological level had been breached.

China mulls options to support yuan and curb outflows

Beijing has also orchestrated an unprecedented swing in the offshore yuan market over the past three days, incurring huge losses for “yuan bears”, or investors who are betting on the currency weakening. It has squeezed yuan supply in the market and pushed the overnight yuan ­borrowing rate toa combined 2.4 per cent on Wednesday and Thursday, the biggest two-day gain ever.

“The PBOC hopes to curb market expectations by intervening in the offshore yuan market and intends to maintain [exchange rate] stability ahead of the Chinese new year”, said Zhao Hongyan, an economist with ­Huatai Financial Holdings in Hong Kong.

But the rebound in the value of the yuan proved short-lived – most of the gains in the offshore rate were erased yesterday.

Although the yuan mid-price was set at 6.8668 yesterday morning, the yuan weakened quickly to 6.9266 at market close in the onshore market.

China may tighten capital controls as yuan outflow continues

Bank of Communications ­analyst Liu Jian said the yuan still faced depreciation pressure, and this could intensify after Donald Trump was inaugurated as president of the United States on ­January 20.

China may eventually have to choose between the exchange rate and its foreign exchange reserves. For now, Beijing appears to be leaning towards a stable ­yuan.

“The forex reserves are a very important tool to stabilise the exchange rate … and it’s the right time to use this tool to defend the yuan,” Liu said. “It’s worth it.”

Fraser Howie, director of Newedge Financial in Singapore, said the desire to prevent the yuan from breaking the seven barrier and to keep the forex reserves above US$3 trillion was “craziness” in terms of a free ­market.