Feb 02, 2018 01:18 AM

What's Next for Yuan After Record Monthly Gain?

The People's Bank of China has shown few signs of intervening to rein in the yuan's strength. Photo: IC
The People's Bank of China has shown few signs of intervening to rein in the yuan's strength. Photo: IC

The Chinese currency extended its yearlong rally to post the biggest monthly appreciation against the U.S. dollar in more than two decades as the greenback fell and confidence in the world's second-largest economy increased.

The yuan, also known as the renminbi (RMB), strengthened around 3.5% to 6.2888 against the dollar in the onshore spot market in January, the most since the Chinese currency was revalued in 1994. In 2017, the yuan appreciated 6.7%, reversing three years of declines.

The greenback lost ground against all major currencies last month, a decline that was welcomed by U.S. Treasury Secretary Steven Mnuchin last week. Speaking at the World Economic Forum in the Swiss village of Davos, he said a weaker dollar was “good for us as it relates to trade and opportunities.”

The Dollar Index, which measures the value of the greenback against a basket of currencies of the U.S.'s trading partners, declined by around 5% in January and has fallen almost 14% since a peak on Dec. 28, 2016 after Donald Trump was elected president.

The People's Bank of China (PBOC), which has repeatedly said it wants to see stability in the yuan while also encouraging volatility, has shown few signs of intervening so as to rein in the yuan's strength. Analysts aren't convinced it will step in this time, even though in the past the PBOC has intervened when the currency has strengthened or weakened beyond what the authorities were prepared to tolerate.

Intervention not needed

The PBOC could allow the yuan to appreciate further to send a message to the market that flexibility of the currency cuts both ways.

“We don’t think the current appreciation of the yuan will lead the PBOC to step in,” Cheng Shi, chief economist of ICBC International, the Hong Kong subsidiary of banking giant Industrial and Commercial Bank of China, said. “We estimate that the (real) effective exchange rate of the yuan against a basket of currencies is now very close to the equilibrium level and its stability has been enhanced sharply. Therefore there is no need (for the central bank) to intervene.”

Cheng was referring to the PBOC's own Renminbi Index which measures the yuan's value against a trade-weighted basket of 24 currencies. Last week, the index rose to 95.7, its highest level since mid-June, 2016, showing the yuan has appreciated against the basket. The central bank has said it wants markets to look at the yuan's value against the basket rather than the dollar.

But neither do analysts believe the yuan's strength will prompt the central bank to loosen capital controls anytime soon. These were imposed from late 2016 when concerns were mounting that the outflows of money that began two years earlier would turn into a flood amid falling confidence in the Chinese economy and expectations the yuan would keep falling.

“One of China’s priorities is to contain financial risks,” Larry Hu, China economist at Macquarie Capital Ltd. in Hong Kong, told Caixin. “I am doubtful there would be across-the-board relaxation on capital controls. Restrictions on overseas acquisitions may not be loosened in the short term either.”

The country’s leaders have listed reining in major risks, particularly financial risks, as one of their top three tasks over the next three years. They also aim to bring the country’s overall leverage “under effective control” within three years and have tightened scrutiny of the overseas acquisitions of Chinese companies, especially heavily indebted private conglomerates.

The Chinese banking regulators have asked lenders to assess their credit-risk exposure to firms including Anbang Insurance, Fosun Group, HNA Group and Dalian Wanda Group, who fueled their expansion with massive borrowing. Many of the companies have now moved to sell their offshore assets to raise capital.

The government’s restrictions on offshore acquisitions “will not unwind because of changes in the yuan’s value given that the measures are intended to limit irrational investment,” Raymond Yeung, a China economist with Australia and New Zealand Banking Group (ANZ), told Caixin.

However, authorities may ease controls on outbound investment in projects in countries involved in the Belt and Road initiative, President Xi Jinping’s signature program aimed at strengthening China’s ties with regions in Asia and Europe through infrastructure investment and construction, said Cheng of ICBC International.

“That will create more room for the acceleration of the yuan’s internationalization,” he said.

Reduce trade friction

Analysts at HSBC Global Research said they expect the yuan to strengthen further this year as China’s improving growth outlook and prudent monetary policy will keep capital outflows under control and as foreign investors buy more Chinese equities and bonds. Data from the central bank show that inflows of foreign funds into the bond market jumped 41% in 2017 to 346 billion yuan ($55 billion).

Beijing may also tolerate a stronger yuan against the dollar to reduce trade friction with the U.S., the analysts said.

“It is easier for China to reform its currency and liberalize the capital account from a position of strength, rather than weakness,” they wrote in a note on Wednesday. “We are still of the view that the authorities do not want a return of one-way RMB appreciation expectations and hence, will at some point later relax capital outflow measures to generate two-way volatility in the exchange rate.”

HSBC this week revised its forecast for the yuan's end-2018 value against the dollar to 6.2 from 6.6, saying that it expected to see more two-way volatility this year.

However, Capital Economics, a London-based consultancy, said in a note on Wednesday that it is sticking to its year-end forecast of 6.4 yuan to the dollar as it expects the dollar to reverse its weakness and suspects that at some point the PBOC will become uncomfortable with the pace of appreciation and want to stop expectations building for further gains.

“We therefore suspect that, if market pressure on the renminbi continues, the PBOC will intervene to temper it,” Mark Williams, the firm's chief Asia economist, wrote in a research note. “In the first instance that might involve further relaxation of controls on capital outflows. And it may include the resumption of direct intervention in the foreign exchange market.”

Louis Kuijs, head of Asia economics at research firm Oxford Economics, has revised his estimate for the yuan's end-2018 value to 6.32 per dollar from a previous 6.41 following the recent strengthening. But he said the PBOC still has its tolerance limits and cautioned that the yuan’s further gains in the onshore market will only last as long as the central bank wants it to.

“The PBOC always has ‘the final say’ on the CNY, in the sense that the currency never moves in a certain direction unless policymakers are comfortable with it,” he said. 

Contact reporter Fran Wang (

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