by Roger Yu Du, an analyst at Global Risk Insights
In the last couple of weeks, the Chinese yuan has lost nearly half of its 2013 appreciation against the US dollar. Investor speculation and central bank monetary policy may both be responsible for fund outflows.
Since mid-February this year, the Chinese yuan has experienced a landslide against the dollar (see chart below), ending years of gradual yuan appreciation. Currently, the USD/CNY rate stands at 6.1448, up 1.7 percent from its lowest point of 6.04 in January 2014.
Chinese yuan against U.S. dollar over one year. Source: Reuters
A weaker yuan was once one of the magic pills for China’s economic boom. It was considered such an effective stimulus to Chinese exports that the Chinese government even re-pegged the renminbi to the dollar during the recent financial crisis. In fact, some still argue that the yuan, after years of appreciation, is still undervalued. Given its apparent influence on Chinese exports, it remains to be seen whether the depreciation of the renminbi will help China’s economy.
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We first need to identify the cause of the yuan’s depreciation. Active intervention from the Chinese government could often be a good or neutral sign, while investors’ speculative runs usually come with troubles. In this case, both forces contributed to the falling renminbi, which complicates the issue.
For its part, the central bank (PBOC) is said to have orchestrated the recent depreciation of the yuan to rattle speculators who believed in its one-way rise. After PBOC initiated its campaign to tighten liquidity and raise interest rates last year, hot money flowed into China, which built up the market’s one-way yuan appreciation sentiment. By sending the speculators a message that the yuan can depreciate, as well as the recent lowering of short-term interest rates, PBOC has tried to stem the inflow of hot money.
Others, however, believe that PBOC’s intervention is just paving the way for further liberalization of yuan exchange rates. “Unless the central bank takes bolder steps toward allowing the market to determine the exchange rate, traders believe the correction could do little more than present speculators with a fresh buying opportunity.”
Whichever explanation is more accurate, PBOC’s currency intervention does not seem to pose much threat to China’s economic development. Yet, despite the sense of security that PBOC is on top of things, potential risks still exist. Credit easing that accompanies the manipulated yuan depreciation may counter the central bank’s efforts to maintain pressure on risky shadow banking in China.
Apart from central bank’s active interference in the yuan exchange rates, investors and speculators also contributed to the depreciation. The yuan in the offshore markets started losing value against the dollar earlier and harder than the onshore market, which may suggest investors play a larger role than PBOC’s alleged intervention. Chinese poor PMI performance and a growing US economy were said to be causes of the money outflow.
However, the most troubling part is not what caused the investment outflow. Rather, it is Chinese firms’ reliance on those investments. Chinese local companies, together with foreign investors, have purchased hundreds of billions of dollars worth of structured finance products that bet on yuan appreciation. Luckily, a further 1.5 percent depreciation of the yuan is likely needed before any severe damage is inflicted on China’s corporations.
