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https://scmp.com/business/article/2096513/stronger-yuan-chinas-best-interest-attract-capital-inflows-and-stabilise
Business

Stronger yuan is in China’s best interest to attract capital inflows and stabilise expectations

China guides the yuan sharply higher after it surges to near 7-month peak, strengthening views the central bank is setting the currency on a firmer path

epa02170645 Chinese Yuan (RMB) notes are arranged for photographs in Shanghai, China on May 24, 2010. While U.S. Treasury Secretary Timothy Geithner and Secretary of State Hilary Clinton continue to press China on appreciating its currency during their visit to the country, recent fall in the value of Euro has made China more reluctant for revaluation, as it will make Chinese goods even more expensive for Europe, the country's biggest trading partner. EPA/Qilai Shen

The Chinese yuan is at its strongest level since last November, appreciating at what has been described as a “violent pace” in the past few sessions.

Analysts widely suspect the Chinese government is behind this appreciation, not only because it wants to flex its currency muscles after Moody’s Investors Service cut the country’s credit ratings for the first time in 28 years.

But more importantly, a stronger yuan is in China’s best interest to deter capital outflows and stabilise expectations ahead of important events later this year, including the US Federal Reserve’s and European Central Bank’s potential tightening of their interest rate policies.

On Thursday, the PBOC raised the yuan’s daily guidance rate by the most in five months. On Wednesday, the onshore and offshore Chinese yuan both hit their strongest levels in more than six months, while the offshore yuan’s borrowing costs also surged to the highest level since January.

Within the past three sessions, the yuan had strengthened by a full 1 per cent.

“The sharp appreciation is probably the consequence of PBOC intervention,” said Qu Qing, an analyst with Huachuang Securities.

Last week, the PBOC announced a new “counter-cyclical factor” to the current fixing rules that determine the daily trading band of the currency domestically.

“The key implication of the change to the fixing regime seems to be that officials are determined not to allow sizeable depreciation,” said Chang Liu, China economist for Capital Economics.

It also gives the PBOC more leeway to ignore market moves when determining the fix, Liu said, further underlining the reluctance at senior levels to allow the yuan to be set by market forces.

A vegetable vendor counts yuan coins while waiting at a market in Huaibei, Anhui province. The general view is growing that the Chinese government is setting its national currency on a firmer path. Photo: Reuters
A vegetable vendor counts yuan coins while waiting at a market in Huaibei, Anhui province. The general view is growing that the Chinese government is setting its national currency on a firmer path. Photo: Reuters

Qu from Huachuang Securities said it looked is as if the central bank has been “motivated” especially into propping up the yuan, given it was Moody’s first downgrade of China’s credit ratings, since 1989.

“The downgrade could possibly ignite bearish expectations among global investors on China’s economic outlook, thus worsening the capital outflows,” he added.

“The central bank may have considered it necessary to intervene, and stabilise the exchange rate.”

Equally important, the PBOC is also likely to have another eye on crucial political events later this year in its paving the way for further reform policies.

These include, most notably, ongoing financial deleveraging to avoid a debt crisis, the upcoming launch of the Bond Connect – a programme to open up China’s bond markets and allow overseas investors to directly buy debt in the mainland – as well as a potential Chinese leadership reshuffle, at the crucial 19th Communist Party Congress this autumn.

With numerous projects being tabled, by an equally numerous number of parties, to fall within the realms of the “Belt and Road Initiative” – China’s international economic blueprint for better regional infrastructure – a stronger yuan is also in its best interest to promote a global currency and attract more investment, said Stephen Innes, senior trader at Oanda Asia Pacific.

That’s a view shared by Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

“The suspicion is that officials want a stronger yuan to deter capital outflows, and allow the kind of reforms that would address some of MSCI’s concerns,” Chandler said.

People walk outside an office building in Beijing on Thursday. China's currency jumped to a near seven-month high, fuelling speculation that the government was pulling strings to prop it up in response to last week's credit rating downgrade by Moody's. Photo: AFP
People walk outside an office building in Beijing on Thursday. China's currency jumped to a near seven-month high, fuelling speculation that the government was pulling strings to prop it up in response to last week's credit rating downgrade by Moody's. Photo: AFP

MSCI, a global index compiler, will decide in June whether to include mainland China’s yuan-denominated A-shares in one of its most-traded indexes.

If included, many global mutual funds and index funds will have to rebalance their fund to add A-shares to their portfolios.

But bear in mind, that MSCI has rejected its inclusion in the indexes three times already, citing concerns about market accessibility and transparency.

Externally, analysts from Bank of America Merrill Lynch suspect the PBOC’s priority is to stabilise the yuan ahead of any potential Fed and ECB policy tightening, which could trigger the US dollar to strength and reignite capital outflows from China.

In the meantime, “better managing political tensions over the CNY’s valuation with the US” could also be a key policy consideration, they add.

Looking ahead, some analysts have already upped their annual forecasts of the yuan’s exchange rate.

Capital Economics, for instance, has raised its target rate to 6.9 to the greenback by the end of the year, versus 7.1 previously.

“We continue to believe the renminbi will appreciate against the dollar, particularly if the former starts to weaken on a broad basis,” said Chang Liu, China economist for Capital Economics.

UBS also on Thursday changed its forecast, predicting the USD/CNY will not move beyond 7 by end-2017 and not beyond 7.1 by the end of 2018, given China’s tighter capital controls and a weakening US currency.

Qu from Huachuang Securities argues against leaving the possibility of a pullback in the yuan to later in the year, due to a slowdown in the Chinese economy and a rebound in the US dollar and euro, after their central banks move to tighten.