Yuan ends 2016 with biggest annual loss since 1994

Most agree the currency will continue to depreciate against the greenback and the pressure of capital outflow will likely persist in 2017

PUBLISHED : Friday, 30 December, 2016, 9:05pm
UPDATED : Friday, 30 December, 2016, 10:58pm

The Chinese yuan is set to record, after what has been a volatile trading year, its biggest annual drop in value since 1994.

However, as 2017 dawns experts generally agree the currency of the world’s second largest economy is set to end the “6 era” – a period with an exchange rate between 6 and 7 against the US dollar – for the first time since April 2008, and enter a new “7 era”.

2016 had started in dramatic fashion, with the offshore yuan tumbling nearly 600 basis points on January 4, and the currency is also set to end the year in similar mood.

On Wednesday night, the onshore yuan broke the critical psychological level of 7 to the US dollar at 11pm, according to a price quoted by Bloomberg.

The milestone scared a lot of people, including the People’s Bank of China, which in an unusual move responded immediately, labelling the price quote “irresponsible”.

The figure eventually turned out to be mistake, but it did show just how easily the markets and the authorities can be spooked when the currency hovers close to 7 per US dollar, particularly after a extremely volatile period.

The yuan is still inching closer to 7 per US dollar, quoted at 6.9493 and 6.9758 in the onshore and offshore markets, respectively, on Friday – the lowest levels in eight and a half years.

That’s close to 7 per cent weaker against the greenback at the beginning of the year, marking the biggest annual loss since 1994, and down for the third year in a row.

The daily reference rate of the yuan set by the central bank was lowered by a total of 4,434 basis points, or 6.82 per cent to 6.9370 per US dollar on Friday.

The yuan has continued to depreciate since Donald Trump was unexpectedly elected the next President of the United States, which analysts say have increasing expectations of inflationary pressure due to the massive potential fiscal spending he promised during his campaign.

The Federal Reserve has since dropped its interest rates, with at least one further cut expected by the market next year.

That prospect has driven the US Dollar Index, which gauges the value of greenback, about 6 per cent higher since the election, following a 2 per cent rise in the three months prior to the vote.

As the index fell to its weakest level in more than two weeks on Friday, many said they expected the strengthening trend to continue in 2017, which in turn will put further pressure on the yuan.

HSBC has forecast the Chinese currency to keep falling against the greenback, tipping 7.2 yuan to the US dollar by the end of next year.

The bank expects the weakness to be most severe in the first two quarters of the year, which may prompt mainlanders to make early use of their US$50,000 annual foreign exchange ceiling.

A Bloomberg survey shows analysts’ median forecast for the yuan is to end 2017 at 7.15 against the dollar, offering a 63 per cent chance of it hitting 7 by the end of the first quarter, which would be a four-fold increase in the probability offered three months ago.

The offshore yuan’s discount to the onshore exchange rate, seen as a gauge of traders’ bearishness on the currency, expanded to the most since December 13 on an intraday basis on Thursday, as traders sold the currency on bets of stronger depreciation pressures as the year draws to an end.

The Chinese currency’s ongoing bleak outlook has been forcing local individuals and businesses to reduce their exposure to yuan-denominated assets and rush into US dollar-denominated ones.

A Bloomberg survey shows analysts’ median forecast for the yuan is to end 2017 at 7.15 against the dollar, offering a 63 per cent chance of it hitting 7 by the end of the first quarter, which would be a four-fold increase in the probability offered three months ago

China’s foreign exchange reserves, meanwhile, shrank by around a quarter from US$3.99 trillion in June 2014 to US$3.05 trillion in November, and the country was displaced in October by Japan as America’s top foreign creditor, as the PBOC spent more of its reserves to defend the yuan.

The steady decline in foreign exchange reserves prompted Yu Yongding, a former advisor to the PBOC, to suggest that once reserves fall below a certain psychological threshold, capital outflows are almost certainly to accelerate.

Yu said China has from now until president-elect Donald Trump’s inauguration to steady the foreign exchange market, and allow the yuan to depreciate to a fair and more natural level.

The central bank, however, seems wary of triggering any further strong depreciation.

The People’s Bank of China on Thursday changed the way it will calculate a key yuan index in the new year, nearly doubling the number of foreign currencies in a basket that is used to set the currency’s value to 24, from 13. The weighting of the US dollar within that basket will be lowered to 22.43 per cent from the current 26.43 per cent.

Analysts said the change was in line with the PBOC’s hope of discouraging investors from exclusively tracking its fluctuations, but added that it would have limited impact on the Chinese currency, which they still expect to weaken further against the dollar next year.

“This means the central bank will pay more attention to the RMB’s stability against a basket of currencies,” analysts at CEBM Group said in a note.

The Chinese authorities have rolled out policies over the past two months to tighten its grip on capital outflows, including restricting mainlanders’ purchase of insurance and investment products in Hong Kong, which were considered an increasingly popular channel for capital outflow. It has also imposed restrictions on Chinese companies’ remittances overseas.