Concerns about China’s stalling growth have dominated the market recently.
Apart from a sinking stock market, there is the specter of the Chinese yuan rapidly losing ground to the US dollar.
These developments have unnerved investors already worried about policy uncertainty and further yuan depreciation.
Amid slowing growth, pressure piles on the renminbi and the risk of capital outflow continues to grow.
In response, China devalued the yuan in August last year.
The widening of the renminbi’s trading band came before the Chinese unit formally gained entry to the International Monetary Fund’s SDR (special drawing rights) basket.
Still, various economic indicators point to flagging growth.
Worries about cross-border liquidity were exacerbated by a stock market meltdown that caused two trading suspensions last week under a newly introduced and highly controversial circuit breaker mechanism.
Meanwhile, expectations of a weaker yuan are weighing on the domestic economy.
The Chinese currency fell at the start of year, inducing sharp fluctuations in the region’s currency markets.
Offshore yuan tumbled to 6.75 against the US dollar, down 2.77 percent from the year before.
The price spread between the onshore and offshore markets has widened to 1,600 basis points.
Undoubtedly, that has unnerved Chinese policymakers and central bank officials.
Yi Gang, vice governor of the People’s Bank of China (PBoC), said policymakers will guide the renminbi to a more flexible regime and allow market forces to play a bigger role in the process.
However, the PBoC is prepared to step in if there is excessive volatility or if there is abnormal movement in the global payment system.
Yi sent a clear signal that Beijing will tolerate a more flexible exchange rate but it won’t allow arbitrage or speculation.
As a result, overnight interbank rates on offshore yuan spiked to a record high, forcing speculators to reduce their short positions.
The redback quickly strengthened in the offshore market.
Meanwhile, the narrowing gap between the onshore and offshore markets eased investor jitters, although it remains to be seen how the government measures will affect the market’s direction in the short term.
The renminbi is likely to stabilize in the medium and to long term given that China’s economic growth and productivity are still relatively high.
There will be more demand for the yuan in terms of trading and reserves. China sits on a foreign exchange hoard of US$3.4 trillion.
The redback might weaken against the US dollar but in a gradual and orderly manner and at a modest pace.
It is likely to hold up well against a basket of currencies.
The PBoC has said it strongly opposes any competitive currency devaluation and it will not stimulate exports by weakening the yuan.
But currency arbitrage is suspected in December’s stronger than expected exports data, calling official figures into question.
China has been cracking down on fake import and export trade receipts since 2014.
And since the August currency devaluation, there has been limited demand for foreign exchange purchases.
China’s exports may see some recovery as US economic growth improves and the eurozone picks up steam.
When that happens, depreciation pressure on the yuan will all but vanish.
This article appeared in the Hong Kong Economic Journal on Jan. 15.
Translation by Julie Zhu
[Chinese version 中文版]
– Contact us at [email protected]