China may act on yuan appreciation versus the dollar
Chinese regulators are not known for taking radical actions. But the latest noises coming out of the China Foreign Exchange Committee over the yuan valuation versus the dollar show an uncharacteristic speed of thought.
As recently as late October, Pan Gongsheng, People’s Bank of China deputy governor and State Administration of Foreign Exchange (SAFE) administrator, which advises the central bank on RMB policy, was telling the Financial Street Forum audience that “the renminbi exchange rate will remain basically stable at a reasonably balanced level”.
A couple of weeks earlier, SAFE deputy administrator Wang Chunying described China’s foreign exchange transactions as “rational and orderly” despite the yuan reaching a six-year high against the currencies of China’s major trading partners. Just two days after Pan’s speech she was reported as saying that this appreciation was normal and that persistent appreciation or depreciation in the yuan was unlikely.
Pan’s comment that “the flexibility of the renminbi exchange rate has been enhanced, enabling it to play a better role in self-regulation” was not exactly welcomed by investors concerned by the currency’s sharp appreciation since September.
China relaxes tech crackdown
Many observers assumed that Beijing was either preoccupied with minimising the impact of Evergrande’s funding problems on the wider financial system, or was anticipating policy tightening from the US Federal Reserve that would take the heat out of the yuan.
In a recent report, HSBC referenced optimism that China’s regulatory crackdown is taking a breather as one of the factors behind its view that the RMB might remain strong in the near term.
Now the China Foreign Exchange Committee has reportedly told commercial banks that they face investigation if their proprietary trading volumes increase by a certain amount in total or relative to what they execute on behalf of clients.
The advice may have been expressed as encouragement for banks to avoid exposing themselves and their clients to FX risk and improve their tracking of proprietary trading, but there is no denying the sentiment behind it.
Yuan price more market driven
So where does China’s attempt to limit speculative trading of the yuan leave the currency? This latest news appears to have caught some analysts by surprise with Iris Pang, ING's chief economist for Greater China, observing that the currency has become more market driven as the counter cyclical factor is removed for now and there have been more channels for inflows and outflows on portfolio investments.
“The first task for the People's Bank of China is to make the economy grow and control inflation,” says AvaTrade chief market analyst, Naeem Aslam.
“Having said that, it doesn’t seem that the central bank is in any rush to show its hawkish side. This means it may be difficult to see any significant upward move in the yuan, especially against the dollar.”
Factors underpinning the resilience of the RMB include China’s strong export growth and steady foreign inflows into the domestic bond market.
Yuan usually strengthens at year end
“A record trade surplus in October likely spurred demand,” says Peter Chia, senior FX strategist at UOB. “Corporates are also rushing to lock in their exchange rates for the year-end. Over the last ten years the RMB has registered its best monthly performance over the USD in December and January.”
Foreign demand for domestic Chinese debt is on track to rival last year’s record high. “The incremental increase is likely due to FTSE Russell raising the weighting of Chinese government bonds in its benchmarks,” adds Chia.
“Investors are also lured to the stable and high yield Chinese government bond offers, in view of the People’s Bank of China’s steady hand in conducting monetary policy in response to the pandemic and keeping inflation under control.”
Pang agrees that portfolio inflows from newly created channels that allow foreign asset managers to invest in both onshore bond and stock markets have contributed to the recent strength of the yuan.
FDI into China is rising
Chong Wee Khoon, BNY Mellon Markets senior APAC market strategist, adds ongoing foreign direct investment (FDI) into the mix, noting that by the end of September investment in 2021 had already exceeded the total for 2020 and was also well ahead of the amount registered in 2019.
“From a more technical basis, the relatively stable yuan this year has also attracted some carry trade positioning,” adds Chong.
In addition, the currency has benefitted from easing Sino-US tensions following the virtual summit between US president Joe Biden and his Chinese counterpart Xi Jinping – the most substantial talks between the two nations since Biden came to office in January.
Adam Button, chief currency analyst at ForexLive says the strength of the yuan as the Chinese economy slows down is a puzzle and that based on any economic fundamental - or the rate of change in fundamentals - it should be softer.
“A peace offering to Biden”
“That said, China hasn’t allowed its currency to move in response to fundamentals for a long time,” Button says. “It’s a market where intervention is paramount because nothing happened in the real world in 2021 that explains why the yuan is one of the world’s strongest currencies. You have to wonder if this is partly a peace offering to Biden.”
To an extent, the strength of the yuan is a reflection of the foreign exchange market’s view that the yuan is still a better bet than most currencies according to Aslam, even though China has faced its own issues in recent months - including the country’s indebted property market.
“Fears around these issues have been allayed in recent weeks, with the PBoC claiming that spillover effects from property markets debt woes were manageable,” he adds.
HSBC has suggested that the outperformance of the RMB amid the global energy crisis and supply chain concerns could also be a reflection of the market expecting select surplus currencies to appreciate to fight against inflation. It notes that RMB appreciated in the second quarter of 2008 and the first half of 2011 when global commodity prices were around current levels.
China will focus on exchange rate volatiltiy
The bank has also reiterated Chong’s observation that the near-term carry for the RMB remains supportive while acknowledging that it is probably slightly overvalued.
So where does the central bank, under whose auspices the China Foreign Exchange Committee operates, go from here?
Zhaoyong Zhang, professor of finance and economics at the School of Business and Law, Edith Cowan University reckons FX market intervention will increasingly focus on the active use of unconventional methods and monetary policy tools with the objective of dampening extreme exchange rate volatility, and that China will use the exchange rate as an automatic stabiliser to adjust the macroeconomy and the balance of payments.
In an analysis of the factors likely to influence the US Treasury Department’s next semi-annual report to Congress on developments in exchange rate policies across the US’s major trading partners, ING’s FX strategist Francesco Pesole suggests that since the last report in April, China’s current account meets the criteria for FX manipulation by exceeding 2% of GDP, but its FX interventions do not.
PBOC not limited to marco-prudential tools
ING estimates that net FX settlements - adjusted for the change in outstanding FX forwards - are worth 1.6% of GDP, below the US Treasury’s 2% threshold.
At the end of May, China’s central bank raised the country’s banks’ FX reserve requirement from 5% to 7%, which briefly halted the yuan’s upward march.
But as the China Foreign Exchange Committee appears to be reminding the banking sector, that the reserve requirement is just one of the macro-prudential tools the central bank has at its disposal to steer FX interests.