China is facing an uphill battle to maintain an orderly depreciation of the yuan as investors pile up bearish bets against the currency outside the mainland.
The gap between the yuan’s value against the dollar in the domestic market and in what is known as the offshore market in Hong Kong, has been widening in recent days. On Wednesday, this so-called spread reached 0.0333, its widest since the beginning of October (apart from the day after the U.S. election), although it narrowed a touch on Thursday.
While the Chinese authorities strictly limit the way the yuan trades at home, it can be bought and sold more freely in Hong Kong. But its value against the dollar is usually about the same in both markets.
The widening gap now is complicating the central bank’s strategy of letting some air out of the currency at a pace Beijing dictates. The two yuan markets at home and in Hong Kong often feed off each other. Moreover, a weaker yuan offshore could encourage more Chinese businesses and individuals—the mainstay of the mainland market—to seek to convert their currency into dollars, potentially adding downward pressure on the domestically traded yuan.
China has tolerated a weaker yuan since early October, right after its entry into the International Monetary Fund’s elite group of reserve currencies, acknowledging that a cheaper currency is the price of using easy money to prop up the economy.
The pace of depreciation has quickened since Donald Trump’s surprise U.S. presidential-election win sent the greenback soaring and emerging-market currencies tumbling. The yuan is down 6.2% against the dollar this year in onshore markets, reaching 6.9152 against the dollar on Thursday, with more than a third of the drop in the past two weeks.
The People’s Bank of China is unwilling to let the currency slide too far, too fast, for fear that might lead to destabilizing capital flows out of the country.
Investors in offshore markets have, though, been pounding the yuan weaker, in the apparent belief that the central bank may struggle to control the pace of its decline.
“The PBOC may intervene” to shore up the yuan, said Prashant Singh, a senior portfolio manager at Neuberger Berman in Singapore. But he said he expects the Chinese currency to fall further because of the gloomy outlook for global trade and the diverging economic trajectories in the U.S. and China.
“Central-bank-led interventions are typically temporary in nature,” Mr. Singh added. “The fundamental factors still point to weakness.”
Already, in the past week, some state-owned banks—which often act as proxy for the People’s Bank of China—have sold dollars to support the yuan after it dropped to its lowest level against the dollar in eight years onshore, traders say.
The central bank has also been setting the yuan’s daily official rate against the dollar, known as the “fix,” somewhat stronger than implied by the greenback’s strength against other global currencies in recent days, according to analysts, indicating its desire to avoid too sharp of a decline. The yuan hasn’t fallen as much against the dollar as have other currencies such as the yen, the euro and the Korean won recently.
The PBOC didn’t respond to requests for comment.
Earlier this year, when the gap between the yuan’s value at home and in Hong Kong also widened, the Chinese central bank directed state-owned banks to buy large quantities of yuan in the Hong Kong market, sending overnight borrowing costs to elevated levels that effectively prohibited investors from wagering against the currency.
This time around, however, short-term overnight borrowing costs in Hong Kong have remained around levels that analysts consider normal, suggesting little intervention offshore.
‘We don’t need to worry too much about the short-term depreciation of the yuan.’
One factor that might have limited China’s ability to intervene more aggressively, analysts say, is its shrinking foreign-exchange reserves. The stockpile, still the world’s largest of its kind, fell to $3.12 trillion last month, its lowest since 2011. That compares to a record $4 trillion in June 2014.
Some analysts within China, including prominent economist Yu Yongding, are now urging the central bank to adopt a more flexible exchange-rate regime to help the yuan find its true market level.
The costs of intervention, they say, have become too high and could encourage capital flight. They have called on Beijing to take the step before Mr. Trump takes office in January: The New York businessman has pledged to label China a currency manipulator and to slap higher tariffs on Chinese goods.
“We have capital controls as the last line of defense,” Mr. Yu wrote in an article published in state media this week. “We don’t need to worry too much about the short-term depreciation of the yuan.”
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