Performances of global financial markets have become quite bipolar since the US presidential election.
Funds are leaving emerging markets and flowing back to the US, pushing US equity markets to new highs while pounding the currencies of emerging countries.
The trend has accelerated the decline of the Chinese yuan.
Faced with the choice of defending the currency or preserving China’s foreign exchange reserves, the People’s Bank of China has obviously opted for the latter.
This is understandable as China’s foreign exchange reserves have already dropped to US$3.1 trillion from the peak of US$3.99 trillion in June 2014.
The mainland central bank has to be cautious.
The yuan has thus continued to weaken and the offshore price has tumbled below 7 yuan against the US dollar.
This is a world apart from years ago when the official daily fixing rate for the Chinese currency strengthened past 6 yuan in the middle of an appreciation cycle.
Some also believe Beijing is taking advantage of the strong dollar to speed up the reform of the exchange rate regime.
Still, sustained and accelerated yuan depreciation has begun to undermine market confidence.
Although Chinese authorities have been articulating that there is no basis for the yuan to depreciate in the medium and long term, market participants took little comfort from the assertion.
They argue that there is no clear definition of what medium and long term means, or more importantly how China defines depreciation — is it against the greenback, or against a basket of currencies?
The renminbi has slipped to sixth place as a settlement currency, according to the Society for Worldwide Interbank Financial Telecommunication, an indication that foreign countries are less willing to hold and use the Chinese currency as it keeps falling.
Investors should watch out for new measures from Chinese authorities as they respond to a weaker yuan by tightening their grip on capital outflow.
This article appeared in the Hong Kong Economic Journal on Dec. 5
Translation by Julie Zhu
[Chinese version 中文版]
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