The People’s Bank of China (PBoC) will require banks trading currency forwards to set aside reserves from Oct. 15.
The move aims to curb speculation on further yuan weakness and alleviate the pressure on the central bank to directly intervene in the market.
It could be a prelude to Beijing’s tightening of the foreign exchange market.
The PBoC has changed its tack from direct intervention in the spot market to intervention in the forward market. This could be a sign that Beijing might tighten the foreign exchange market and stir up market expectation for capital controls.
It could be a step backward for China’s currency reform. Accelerating the renminbi’s devaluation will worsen capital flight, which would in turn exacerbate yuan depreciation and form a vicious circle.
The International Monetary Fund said in an Aug. 5 report that it has decided to extend the current basket for its Special Drawing Rights until Sept. 30, 2016. This year’s review was expected to be completed in November 2015 when the IMF board will decide whether the renminbi will be included in the SDR basket or not.
One week after the IMF report, the Chinese central bank announced a change in its daily fixing of the currency, weakening it in line with the spot rate.
In response to the action, the IMF commented that the new regime will allow market forces to play a bigger role. It also expressed confidence that China will be able to achieve a free-floating exchange rate within two to three years.
Emerging market currencies have continued to weaken since late 2014, and the PBoC has managed to stabilize the daily fixing for the yuan regardless of the falling spot rate.
If the central bank fails to defend its exchange rate, the IMF may refuse to include renminbi in the SDR basket.
If so, China may need to wait for another five years for the next review. In this case, the Chinese currency may remain steady in the short term.
Yuan devaluation is already a market consensus. In order to stabilize the currency, the PBoC unveiled the new rule to gain more power in fighting speculators for yuan depreciation.
As much as HK$9.3 billion flowed into Hong Kong amid the global market turmoil. Some say investors in yuan-denominated assets have switched to the Hong Kong dollar through various channels, in order to avert further exchange losses. Others attribute the increasing demand for Hong Kong dollars to the sell-off of yuan assets like dim sum bonds.
China’s newly emerging rich have already snapped up overseas properties in recent years. A recent survey in July by China Confidential, a Financial Times research service, showed that over 60 percent of wealthy Chinese citizens plan to increase overseas assets in the next two years, and their favorite is residential property, followed by fixed-income securities, commercial property, trust products and life insurance.
Also, Chinese investors have been flooding Canada’s real estate market in the last couple of months. Any decent property in cities with large Chinese population like Vancouver are easily sold. Overseas property investment will enable investors to diversify risk from yuan depreciation.
On Tuesday, Dow Jones futures slumped over 300 points, and the German market plunged below 10,000 points. Also, the Japanese market suffered a loss of over 700 points.
The sell-off in equity markets worldwide is mainly due to uncertainties surrounding the US rate hike.
This article appeared in the Hong Kong Economic Journal on Sept. 2.
Translation by Julie Zhu
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