Yuan Expansion Hits Hurdles

(Beijing) – The bright days of rising yuan  appear to have clouds entering the horizon, with many analysts citing slower appreciation rates and volatility in global markets.
 
On December 8, the exchange rate of the yuan against the U.S. dollar declined for the seventh consecutive day and exceeded the 0.5 percent daily limit.
 
Accompanying the changing outlook on the yuan are declines in capital inflows. In October, China's funds outstanding for foreign exchange reserves declined by 25 billion yuan from September to 25.5 trillion yuan, the first drop since 2008.
 
The central bank later said its funds outstanding for foreign exchange fell by 89.34 billion yuan in October from the previous month to 23.29 trillion yuan, the first monthly drop since December 2003. The data indicated expenditures by other financial institutions on forex purchases increased 64.45 billion yuan in October.
 
Meanwhile, according to the State Administration of Foreign Exchange, China's foreign exchange reserve growth in the third quarter was US$ 92.1 billion, a drop of US$ 50.9 billion from the second quarter.
 
Market analysts said that the data reflected the increasing willingness of financial institutions and enterprises to hold foreign currency amid rising speculation on yuan depreciation.
 
Since late September, the yuan market in Hong Kong and the Yuan Non-Deliverable Forward Contracts both indicated declines in the yuan. On December 8, yuan to U.S.dollar rate in the one-year NDF contract hit 6.3925. At the same time, the central parity of the yuan's exchange rate against the dollar remained around 6.33 to 6.34.
 
Analysts said the future trend of the yuan will depend on the performance of the U.S. dollar. As the European debt crisis worsened, investors have returned to purchase U.S. Dollar assets to prevent risks, pushing up the value of the dollar.
 
A Caixin survey of 20 economists showed that most of them expect the yuan to continue a rising trend through the end of the year. "The NDF is an index of market expectations that often fluctuates. If any breakthrough is made in the European debt crisis, expectations for yuan depreciation will not remain for long," said a trader from a Shanghai-based bank.
 
 
Liu Dongliang, senior analyst at the financial market department of China Merchants Bank, said  demand for U.S. dollars has been pushed up by various factors, including capital outflows, need for foreign currency debt repayment and interest rate arbitrage, as well as a stronger outlook on the U.S. dollar.
 
"The situation will continue for a while," said Liu, adding that the trend for yuan appreciation will not change in the long term. "By mid-2012, the yuan is likely to rise by 3 percent compared to now," added Liu.
 
Other analysts echoed concerns that the European debt crisis would continue to put a downward pressure on the value of the yuan. "There is still no hope to be seen in Europe, only bad news. The 2012 economic growth of Europe may decline 1 or 2 percentage points and may even confront greater turmoil. Therefore, the outlook for Chinese exports is also weak," said Stephen Green, chief China economist from Standard Chartered Bank.
 
With the spread of crisis, a number of emerging economies such as Brazil, Thailand and Indonesia have announced interest rate cuts. China's central bank also reduced the reserve requirement for financial institutions by 0.5 percentage point for the first time in three years. The move sent a signal to markets that monetary policy would turn to be loosened, but concerns of a slowdown in the Chinese economy still loom large.
 
Data from the China Federation of Logistics and Purchasing showed that China's November  Purchasing Managers' Index declined to 49 percent, the first time that the reading dropped below 50 percent which indicates a contraction. Indices for new export orders continued on a downward trend.
 
What introduced more uncertainty to China's macro-economy is continued government controls on the housing market and worries of possible widespread debt default by local governments.
 
"The deposit requirement cut was only a signal to monetarily boost economic growth, it will not bring a big change in liquidity issues," said Peng Cheng, chief China economist from Citigroup.
 
But some remain confident to the yuan. Zhang Yansheng, director of the Institute for International Economic Research under the National Development and Reform Commission, said current issues surrounding the housing bubble and local government debt have not created systematic risks to China's economy.