Yuan weakness is making a virtue of necessity

Beijing may be making a virtue out of necessity. Pressure has been building on the yuan to depreciate since the International Monetary Fund included the currency in its special drawing rights basket. The inclusion lends a much sought-after prestige for the nation’s policymakers. They may also be more willing to give market forces a freer hand and let the yuan weaken.

It appears the broad strength of the US dollar has been the main cause of the yuan’s depreciation, rather than something that is happening within the mainland. Though the US Federal Reserve has held interest rates in order not to affect the presidential election, it is likely to raise them next month.

The “offshore” renminbi, called CNH – which trades outside China and is not subject to a trading band set by the central bank – has been going south. Mainland policymakers may let the CNH lead the “onshore” value of the yuan for now.

Yesterday the People’s Bank of China set its fixing rate below 6.8 per US dollar for the first time in more than six years, paving the way for further depreciation.

Since August last year, the central bank has adjusted its approach to the mid-point fix and allowed market forces a greater play. This is a welcome trend in the gradual liberalisation of the currency.

Still, with the likely US interest rate rise and with Beijing cracking down on speculation in prime city real estate, the pressure on the yuan to weaken and the urge for investors to move money abroad will continue.

Beijing is not without defences, though. The yuan ­depreciation and capital flight may reinforce each other, but Beijing can always beef up capital controls.

This appears to be the more attractive option than continuing to defend the yuan’s value by burning through the country’s reserves. The yuan’s fall may introduce greater volatility, but for now, the nation’s policymakers seem to think it’s a price worth paying for helping the economy through its current slow patch.