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One year on, lower yuan and fewer jitters

ONE year after China’s surprising devaluation of its currency, the central bank seems to have assuaged market panic as it leads the yuan slowly lower.

Fear, at least for now, has largely disappeared from financial markets, with currency options showing their least bearishness in almost two years.

On August 11 last year, the government-controlled yuan depreciated 1.8 percent, triggering a sharp outflow of US$175 billion in the ensuing three months. The People’s Bank of China reignited currency fears in January by paring the yuan’s reference rate for eight days in a row. The central bank sets a range within which the yuan can trade.

Analysts said the central bank is becoming quite adept at communicating with the market.

“The PBOC has anchored market expectations,” said Nathan Chow, an economist at Singapore-based DBS Bank.

He noted that the yuan’s drop to a five-year low of 6.6971 against the US dollar on July 19 didn’t cause much of a market ripple.

China’s foreign exchange regulator suggested in a recent announcement that cross-border capital flows will be kept under steady control, given relatively sound economic fundamentals, a solid current-account surplus and ample foreign-exchange reserves.

“The market has now developed a consensus that the yuan will be devaluated on a gradual basis in the mid-term.” Chow said.

The restored stability comes as China prepares for the yuan’s inclusion in the International Monetary Fund’s basket of reserve currencies. Mark Mobius, executive chairman of Templeton Emerging Markets Group, said in an interview that yuan “volatility will be avoided at all costs” because of that.

Analysts predict China won’t be changing its foreign-exchange policy stance or the yuan’s value before the G20 summit in Hangzhou next month. Still, China’s imports and exports aren’t expected to improve much in the third quarter. The weaker currency somewhat offsets the effects of sluggish global demand but that scenario isn’t expected to be much of a shot in the arm at this stage, said Commerzbank AG economist Zhou Hao.

A narrowing spread between the value of the yuan offshore and onshore since January seems to echo those views. The smaller gap provides a more stable channel for foreign investors who need to hedge mainland assets in offshore markets in Hong Kong.

After the yuan joins the IMF currency basket in October, it will hold a 10.9 percent weighting in the Special Drawing Rights administered by the fund. That will be higher than the yen’s 8.3 percent weighting and sterling’s 8.1 percent weighting, but still below the euro’s 30.9 percent and the greenback’s 41.7 percent.

The inclusion may not accelerate China’s ability to attract trillion-dollar inflows of foreign investment in the short term, as some financial institutions once predicted, but it could be a positive sign for market sentiment on China, said Bloomberg LP Asian economist Chen Shiyuan.

“Foreign investors don’t allocate their assets based on the proportions in the SDR basket, so the symbolic meaning of including yuan is bigger than its substantive meaning.” Chen told Shanghai Daily. “But for sure, it could partially eliminate market bias on the yuan’s fluctuation because it reflects the IMF’s positive outlook for China’s economy and financial reform.”

Still, some argue that market intervention and persistent weakness in the yuan have undermined the government’s efforts to expand its global use.

The Chinese currency accounted for 1.72 percent of worldwide transactions in June, the smallest proportion since October 2014, according to the Society for Worldwide Interbank Financial Telecommunications (SWIFT).

To expand global use amid expectations of a weaker yuan, some analysts have suggested that the central bank’s next move needs to be promoting the yuan as an overseas funding currency, going beyond its current role as a currency only for trade settlement.

Cross-border trade settlement used to be the main channel for raising the yuan’s profile overseas. Its percentage of China’s total trade volume jumped from nearly zero percent in 2009 to almost 35 percent by the end of 2015. The growth rate moderated to nearly 25 percent by this June.

“With more and more Chinese companies seeking overseas development, local fundraising demand is surging,” DBS Bank’s Chow said. “They raised the money in dollars for the past decade, but with a depreciating yuan, the government could encourage companies to make more renminbi-dominated overseas direct investments, like setting up new plants or engaging in mergers and acquisitions.”

With the blueprint of the government’s “One Belt, One Road” initiative backing up such overseas investments, Chow estimates that the scale of yuan-dominated overseas direct investment could surpass shrinking foreign direct investment in China as early as the end of this year.

With overall improvement in the exchange rate and the central bank’s relatively strong control of China’s currency, UBS said in a recent report that policymakers are likely to keep the nation’s foreign reserves somewhere above US$3 trillion and the value of the yuan against the dollar within 6.8 by year’s end.

Although a weaker yuan increases the costs of overseas holidays and the costs of wealthy Chinese buying up properties abroad, the lower yuan hasn’t dented enthusiasm in either sector so far.

The number of Chinese tourists going abroad in the first half of this year rose 4.3 percent from a year earlier to 61.9 million. In 2015, outbound tourists spent US$137 billion for foreign holidays.

The wealthy continue to seek real estate in the US, Hong Kong and Australia to park their money offshore. Investment in overseas property in the first five months of this year totaled US$17 billion, according to property advisor DTZ/Cushman & Wakefield. That figure was equal to two-thirds of total investment in overseas property last year.

“Domestic investors might find themselves able to seize the window of opportunity for investing abroad because short-term devaluation pressure is partly written off by the government’s need for market stabilization,” Chen said.


 

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