Yuan's inclusion in SDR basket eases traders’ concern about currency’s volatility
One month before China’s renminbi is formally included in the currency basket of the International Monetary Fund’s Special Drawing Rights, or SDRs, analysts and currency traders say their concerns about the yuan’s volatility have eased.
“It’s the beginning of a new era for the yuan to play a bigger role in the global financial system,” said Candy Ho, the global head of RMB business development at HSBC in Hong Kong.
While the yuan is still not freely convertible into other currencies, and the government still exerts tight control over cross-border capital flows, the prospects for further liberalisation are positive, analysts said.
“The official inclusion of the yuan into the SDR market will provide reassurance for foreign investors, encouraging sovereign investors and other long-term investors to participate in CIBM programme to access China’s bond market even more,” said Wang Ju, senior foreign currency strategist at HSBC in Hong Kong.
The World Bank this week became the first foreign institution eligible to sell SDR bonds in China, with the People’s Bank of China approving a 2 billion SDR programme. A quarter of that, or 500 million SDRs (US$700 million) were marketed on the interbank bond market on Wednesday.
As bond yields around the world declined to record low levels and even negative, China’s bond market, which offers an average of 2 per cent to 3 per cent yield for investors, is attractive for overseas investors, according to Wang.
Meanwhile, after significant depreciation of the yuan against the US dollar, foreign investors “believe that the currency is closer to its equilibrium level and more investors are looking into investing inside China,” said HSBC’s Ho.
With capital inflows to increase, Chinese government is expected to face a more urgent need to accelerate the pace to loose its restriction on cross-border capital flows, making the yuan a more flexible currency.
The prospect of the yuan’s exchange rate is providing reassurance for the government to do so.
In the past one year, the offshore exchange rate of the yuan has weakened by 4.7 per cent against the US dollar, while the onshore yuan rate has depreciated by 3.9 per cent.
Meanwhile, the CFETS index, the yuan valued against a basket of trade-weighted currencies, has weakened by 8 per cent since last December.
In addition, the one-year non-deliverable forwards on the yuan against the US dollar is quoted at 6.8380 on Wednesday, compared to 6.6912 in the offshore market and 6.6790 in the onshore market.
“Both the Chinese government and the market are now more comfortable with the yuan’s depreciation,” said Wang. “That’s different from January and February this year when there were a lot of concerns in the market about the yuan’s volatility.”
“The process from fears to acceptance (of the yuan depreciation) is not only an evidence that the market is more confident about China’s foreign exchange reforms, also a sign that the market has realised that it’s more efficient and healthy for China to adopt more flexible exchange rate in return for long-term stability.”
According to HSBC forecast, due to a divergence of monetary policies in China and the US, yuan is going to stay relatively weak this year and next year, but depreciation pressure will ease after that and there is no basis for long-term depreciation.
“We maintain the forecast of yuan at 6.9 against the USD by the end of this year, and the recent hawkish comment from the Federal Reserve will not change that forecast,” said Wang.
Capital outflows, a concern for the Chinese government is also showing signs of abating.
“Since the second quarter, China’s foreign exchange reserve have declined only slightly, showing that capital outflows are manageable.”
When the government is more confident about the management of cross-border capital flows, it will likely to accelerate the pace to remove the restriction on capital flows, Wang said.