Author: Lingling Wei
Posted on: The Wall Street Journal, December 29th, 2016
China’s central bank is adjusting the mix of foreign currencies used in setting the yuan’s official daily value—a change analysts said should help ease recent pressure weakening the Chinese currency.
Starting Jan. 1, the central bank will expand the number of currencies in the basket uses to calibrate the yuan’s value to 24 from 13 and reduce the weighting given to the U.S. dollar to 22.4%, from 26.4%, according to an announcement by the central bank’s China Foreign Exchange Trade System late Thursday.
China wants a slightly weaker currency to help exporters and maintain competitiveness with other economies as the dollar rises, but it doesn’t want to lose control. By diluting the dollar’s share and bringing in currencies from the Korean won to the Saudi riyal and Swedish krona the People’s Bank of China is giving itself more room to maneuver to keep the yuan from falling too fast, analysts said.
In recent weeks, the yuan has buckled under uncertainty about China’s economic performance, a surging U.S. dollar following Donald Trump’s presidential-election victory and escalating flows of Chinese currency moving offshore. A rapid descent in the yuan’s value would raise fears the central bank is losing control, undermine confidence in the economy and accelerate the outflows.
The potential for faster U.S. interest-rate increases could add even more downward pressure on the yuan, with some analysts and investors predicting that the currency could break the psychologically important seven-yuan-per-dollar level as soon as next month. So far this year the yuan has dropped 7% against the dollar, nearly double the decline from the year before.
How to manage the yuan’s value has become a hot topic in official circles since a nearly 2% devaluation 16 months ago shocked global markets. In the past year the central bank has sought a less abrupt path, constricting channels for moving money out of the country and managing the pace of depreciation.
The central bank controls the mainland trading of the yuan by specifying an official rate for the yuan against the dollar and then allowing the currency to move 2% above or below the so-called daily fix. Since the beginning of this year, the central bank has been taking into account the yuan’s performance against both the dollar and a wider selection of currencies when determining the daily fix. That move has paved the way for the yuan’s gradual deprecation, which helps make Chinese goods cheaper in foreign markets.
With the pressure building for further depreciation, Chinese leaders have been trying to assert greater control and slow the decline. At a top-level meeting earlier this month, Chinese leaders said that maintaining the yuan’s “basic stability” would be a main economic task for 2017.
Expanding the currency basket and reducing the dollar’s weighting could help “reduce fluctuations of the daily fix and stabilize market expectations” for the yuan, said Zhu Chaoping, China economist at UOB Kay Hian Holdings Ltd., a Singapore-based investment bank.
The new basket will include the currencies of almost all of China’s trading partners and therefore will be more representative of the yuan’s performance against its peers, the announcement said.
Still, many analysts and investors said the basket can play only a limited role in steadying expectations for the yuan. A bigger issue, they said is how to break the cycle of greater depreciation leading to more outflows and more stress.
“The one-way depreciation has led to rising depreciation expectations, resulting in huge capital outflow pressure,” said China economist Larry Hu at Macquarie Securities, a Sydney-based investment bank.
The authorities face an imminent test as the clock is reset on individuals’ annual foreign-exchange quotas. Currently, Chinese citizens are allowed to exchange up to $50,000 worth of yuan a year. The opportunity to exchange yuan in 2017 is expected to set off fresh outflows, many analysts and economists said, potentially forcing Beijing to further tighten capital controls.
In recent weeks, the central bank has sought to slow the pace of the yuan’s depreciation by market interventions and a stronger-than-expected daily fix. Some of those efforts, like the actions to sell dollars and buy yuan, threaten to drain more liquidity from China’s financial system at a time when the demand for cash from ordinary Chinese is growing ahead of Lunar New Year in late January. Chinese traditionally make cash gifts during the Lunar New Year celebrations.
That demand has led to calls on the central bank to release more funds for commercial banks to lend. So far, the central bank appears to be maintaining a tightening bias in its monetary stance, analysts said, as any credit-loosening could add to more pressure on the yuan.