Yuan weakens against US dollar as central bank move takes wind out of currency’s sails

PUBLISHED : Monday, 11 September, 2017, 2:21pm
UPDATED : Monday, 11 September, 2017, 11:08pm

The yuan’s recent rally against the US dollar ended on Monday, after the People’s Bank of China unwound a two-year policy aimed at curbing the Chinese currency’s depreciation, which had guided its value to a 21-month high against the greenback.

Last week, the Chinese central bank scrapped a 20 per cent reserve requirement that financial institutions had to set aside for buying dollars for clients, effective Monday. The cost, first imposed in 2015, was designed to limit short speculation in the yuan while the currency was weakening from the spectre of capital outflows.

Following the latest move, the yuan weakened by as much as 0.49 per cent to 6.5263 per dollar on Monday, the biggest intraday depreciation since December 15 last year.

“The move shows a clear desire to alleviate the appreciation momentum,” said Aidan Yao, senior emerging Asia economist at AXA Investment Managers in Hong Kong. The People’s Bank of China, the Chinese central bank, “may consider removing controls on outbound flows to counter flows,” he said.

By making yuan forwards cheaper to trade, the policy is likely to stimulate importers to increase the hedging for the yuan’s drop, while allowing speculators to short-sell the currency.

The policy may also act as a catalyst to attract new inflows into China’s onshore bond market from foreign investors. International investors’ buying of Chinese debt slowed in August, reflecting lingering concerns over the Bond Connect scheme partly because of the lack of hedging instruments available to foreigners to manage currency risks.

“That is particularly important to foreign investors with bond investment exposure in the onshore market” via the Bond Connect programme that lets global traders invest in China’s bonds, Mizuho said in a research note.

Such trades may exert downside pressure in the yuan over the short-term, analysts said.

While the yuan market may respond in a knee-jerk reaction to the policy, the yuan will likely consolidate and trade around the 6.50 level for now, Scotiabank said.

The move -- combined with a deteriorating US dollar -- underscored rising optimism, as China’s policymakers found their grip on the economy and put a halt to the nation’s capital flight, reflected in foreign-exchange reserves that rose for the seventh month in August to US$3.09 trillion.

Analysts also expect authorities to further relax capital controls and other restrictions on cross-border transactions if confidence in the currency continues. Beijing has been blocking overseas investment by companies and urging banks check loans to active acquirers since early this year.

“Maybe some partial and controlled liberalisation, for instance allowing overseas direct investment in some areas, is possible as the momentum for yuan continues to build,” Yao said.

A major relaxation in the policy regarding outbound investments may not take place ahead of the Chinese Communist Party’s 19th congress due on October 18, when the next line-up of China’s leaders will be selected, he said.

The yuan has strengthened by 2.4 per cent in the past month, the best performer among 11-most traded Asia currencies, amid a weaker US dollar and optimism in China’s economic fundamentals.