Across The Border

Yuan’s gains an opportunity for China’s central bank to push reform, not a matter of concern

Two recent changes to reserve requirements that make it easier to short yuan raise concerns authorities are worried about the currency’s rise, but analysts see confidence in current exchange rate

PUBLISHED : Tuesday, 12 September, 2017, 3:40pm
UPDATED : Tuesday, 12 September, 2017, 10:52pm

Changes to some reserve requirements by the People’s Bank of China this week that made it easier to short the yuan onshore and bet against it offshore had raised speculation that the authorities were worried about the currency’s recent strengthening.

But analysts said that the exchange rate was unlikely to be a major concern, as it is still stable in trade-weighted terms, and that instead the central bank may be using the easing of depreciation pressure as an opportunity to increase the two-way flexibility of the yuan exchange rate and resume financial reforms and efforts to push the yuan’s globalisation.

The PBOC cut the yuan’s guidance rate on Tuesday for the first time in 12 sessions to 6.5277 per US dollar. That was down 280 basis points, or 0.43 point, from the previous day, marking the biggest cut in eight months.

The day before, the PBOC had scrapped a requirement for domestic financial institutions to settle foreign exchange forward positions, a move that had been in place since August 2015 when the yuan was weakening sharply. It also removed a requirement for foreign banks to set aside reserves for offshore yuan deposits in China. The two moves have lowered yuan hedging costs and made it easier for traders to buy foreign currencies and short the yuan.

The measures gave rise to market speculation the authorities were worried about renminbi strength, which might hurt exporters, as the yuan surged nearly 2 per cent last week against the US dollar, the biggest weekly gain in more than a decade.

However analysts said that was unlikely.

“The problem with this theory is that, while the yuan has rebounded sharply against the dollar recently, the bulk of these gains have been offset by losses against other currencies,” said Mark Williams, chief Asia economist for Capital Economics.

“We don’t believe that officials at the People’s Bank are so acutely sensitive to the level of the exchange

rate that they are now worried about renminbi strength, (since) it has barely moved in trade-weighted terms.

“Indeed, if anything, Chinese exporters have regained a degree of competitiveness relative to those in other emerging economies since the start of last year,” said Williams.

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The yuan has in fact risen more than 6 per cent against the US dollar since January, recouping some of the 14 per cent it lost between its sudden drop on August 11, 2015 and the end of 2016, although

against the trade-weighted basket tracked by the PBOC, it has risen much less.

The rebound has given Chinese policymakers an opportunity to increase the two-way flexibility of the yuan exchange rate.

“Now that depreciation pressure has abated, policymakers will want to introduce more uncertainty

about the outlook to prevent the re-emergence of a view that the currency will only move one way,” said Williams.

The changes to the requirements are more a reverse of tightening measures introduced when the renminbi was under severe pressure to weaken, he said.

“The PBOC always said that the steps it had taken to repel market pressure on the exchange rate were temporary. Most were always likely to be reversed at some point if the pressure subsided.”

By taking advantage of the globally weak dollar, the PBOC has dislodged the view that the renminbi will only depreciate. But it doesn’t want the appreciation pressure to build too much, either, as that could cause the currency to overshoot, he added.

Becky Liu, head of China macro strategy for Standard Chartered Bank, said the removal of the restrictions suggested China’s confidence has improved in its exchange rate and capital flow conditions.

“These conditions may lead to a further unwinding of temporary measures to curb outflows previously, and pave the way for the next round of financial reforms and renminbi internationalisation,” she said.

Liu expected financial reforms, including of foreign exchange, could accelerate after the 19th Party Congress, which was expected to kick off on October 18th.

The date of the congress, earlier than had been expected, suggested it may be an official consolidation of political power that will allow the government to carry out its reform initiatives with greater efficiency, she said.

“Against this backdrop, 2018 – or even late 2017 – could be a good time to deepen financial reforms, in our view.”