Beijing wins a yuan battle, but will it lose the global currency war?
China’s surging yuan defeats short-sellers by hitting a 6-month high versus the US dollar as the dust settles after Moody’s credit downgrade
The corks should be popping on bottles of champagne at the People’s Bank of China, if Beijing’s policy goal was to defeat investors who dared to bet on a cheaper yuan after Moody’s recent downgrade of China’s sovereign credit rating.
If any speculative forces were attempting to short the yuan, the currency did indeed put them in their place by surging to a six-month high against the US dollar in the Hong Kong offshore market, aided by a behind-the-scenes push from China’s central bank. The Hong Kong offshore market is said to be more sensitive to market forces than its onshore counterpart.
As a result, the overnight yuan interbank borrowing rate has shot up to 42.8 per cent, an unhealthy sign for the yuan market. Beijing’s meddling in the yuan exchange rate also sends a signal that China is moving away from a promised “clean” floating exchange rate system.
“It is important to remember that China’s exchange rate is still fully in the hands of PBOC,” said Louis Kuijs, head of Asia economics research with Oxford Economics and a former economist with the World Bank. “At any point in time, the PBOC decides to what extent it wants to take market pressures into account as it sets the fixing rate and steers the spot rate. In that sense, China’s exchange rate is a solidly dirty float.”
Meanwhile, the yuan’s approximately 1 per cent appreciation in Hong Kong since May 25 and a 543 basis point upward change in the currency’s mid-point price on Thursday are just the latest examples of the Chinese government’s trend toward peddling back its liberalisation program - contradicting Beijing’s own strategic goal of making the yuan a global currency.
Since the International Monetary Fund included the yuan in the IMF’s Special Drawing Rights currency basket in October, China has in many ways suspended, and peddled back, its pro-market reforms. In addition to strictly vetting outbound yuan flows and tightening capital account controls, last week a murky “counter cyclical factor” was adopted to decide the currency’s daily midpoint price, making the yuan mechanism even more complicated.
Zhang Ming, a researcher with the Chinese Academy of Social Sciences, wrote in a research note that the counter cyclical factor “may make it more difficult for market players to anticipate exchange rate movement to reduce [the] transparency of [the] yuan pricing mechanism”.
While China has managed to prevent a big depreciation of the yuan against the US dollar, the Chinese currency’s use in global finance has been shrinking. The latest data from global payment system Swift showed that the yuan slipped to the seventh most actively traded currency in April, falling behind the Swiss franc. Its 1.6 per cent market share is far behind the dollar’s 42.1 per cent share.
And there’s nowhere better to display the harmful impact of Beijing’s rigid yuan policy than Hong Kong, the first and most important stop in China’s endeavour to take the yuan beyond the nation’s borders. Approximately a decade after the first yuan-denominated “dim sum bonds” were issued in Hong Kong, the market remains largely idle.
“Internationalisation of the yuan...is not a short-term policy target,” said Li Daokui, a Tsinghua University professor who served as an academic on the PBOC’s monetary policy committee from 2010 to 2012. “The most important thing for now is to ensure financial stability and to control liquidity.”
PBOC is engineering a strong yuan partly in response to the downgrade by Moody’s, the ratings agency’s first on China since 1989, and ahead of a possible rate hike by the Federal Reserve in mid-June, analysts said.
“Beijing takes Moody’s downgrading seriously and it will put deleveraging at a priority policy,” said Zhou Hao, chief emerging markets economist at Commerzbank in Singapore. To clean up the domestic financial mess, China needs to create a stable external environment, he said.
“Authorities need to manage market sentiment on the yuan to avoid a sharp yuan depreciation...when they push forward the deleveraging,” Zhou said.
Zhao Yang, chief China economist with Nomura Securities in Hong Kong, said the yuan’s abrupt strengthening may have a political backdrop, namely trade talks with the administration of US President Donald Trump.
If the yuan weakens along with a weakening US dollar, it may give Washington an excuse to complain about China’s currency, said the Chinese Academy of Social Sciences’ Zhang. Added Nomura’s Zhao: “China is facing huge challenges in June. It needs to avoid the depreciation pressure from being intensified and to ward of financial risks.”
To be sure, the yuan’s appreciation in the past few days may be due more to changing economic and market fundamentals than the whim of China’s central bank, some analysts argued.
Deng Haiqing, an economist with JZ Securities, a Chinese brokerage, wrote in a note that China’s domestic economic stabilisation and monetary tightening, along with curbed money outflows, may have put an end to “a depreciating trend of the yuan since 2014”.
Kuijs of Oxford Economics wrote in a note that the appreciation can be seen as “a delayed response” to the US dollar’s depreciation against other major currencies, earlier in May.