Offshore yuan weakened beyond 6.77 against the dollar on Oct. 21, the lowest in six years.
Chinese authorities explained that the short-term volatility in the Chinese currency is normal and remains in a reasonable range, adding that the yuan’s decline is largely a result of a strong US dollar amid expectations the Fed might soon hike interest rates.
The latest Fed funds future indicates a 73.6 percent chance of a rate hike in December.
Compared with other global currencies, the yuan’s decline has been relatively modest.
In fact, the yuan has appreciated if measured against a basket of currencies.
So what is the real floor of the unit?
It seems the People’s Bank of China (PBoC) has no target or a specific level in mind that it must defend, either in the onshore or offshore market.
The central bank has not intervened in the market in any obvious way recently.
On the other hand, China’s economic growth in the third quarter is basically in line with government target, so there is no urgent need for Beijing to weaken the currency to stimulate growth.
Meanwhile, China’s capital outflow has moderated since October after spiking due to seasonal factors such as people going overseas for holiday during summer.
That means most probably, the yuan’s movement will largely depend on the global currency market instead of PBoC policy and Chinese domestic factors.
Given the strong greenback, the downward bias is set to continue.
Also noteworthy is the widening trading range of the yuan this month, which may signify the PBoC’s bigger tolerance for currency volatility.
In sum, the Chinese yuan is still under pressure in the short term given the strong dollar.
But that does not necessarily mean the yuan would be locked in a downtrend, considering positive factors like China’s stabilizing growth, massive foreign exchange reserves and inclusion of the yuan in SDR basket.
In terms of volatility, I believe the Chinese authorities would tolerate an annual move of 3 to 4 percent against the dollar in either direction.
This article appeared in the Hong Kong Economic Journal on Oct. 24
Translation by Julie Zhu
[Chinese version 中文版]
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