China Switches to Supporting Yuan as Outflows Mount: Currencies

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Managing the yuan is turning into a different game for China’s policy makers these days.

After more than a decade of curbing the currency’s gains to help turn the nation into a manufacturing colossus, there are signs the People’s Bank of China is now propping up the yuan to stem an exodus of capital that’s threatening the economy.

A gauge of capital flows on the PBOC’s balance sheet fell by the most since 2003 last month in a sign it’s selling foreign currency, while the yuan’s reference rate set daily by policy makers is at its strongest-ever level compared with the market price. Chinese Premier Li Keqiang said today the nation would implement measures to manage the economy more effectively and boost competition.

“Everyone thought the movie would never end, and suddenly it ended, so everyone is hurrying to leave,” Kevin Lai, an economist at Daiwa Capital Markets in Hong Kong, said by phone on Jan. 22. “The authorities need to think of a way to keep the audience in the theater” as the economy slows, he said.

China amassed a world-leading $4 trillion of foreign-exchange reserves by mid-2014 as exports surged and capital flowed in, attracted by a currency that strengthened for four consecutive years. Now that the yuan’s gains are faltering, the PBOC is trying to prevent its declines from turning into a rout that could deter investment just as the economy suffers its slowest growth in 24 years.

Yuan Turnaround

The yuan’s onshore rate fell to as low as 6.2569 per dollar today, the weakest level since June, before paring its slide to 6.2542. That’s down from a two-decade high of 6.0406 set on Jan. 14, 2014. China’s currency retreated 2.4 percent last year, after climbing 12.8 percent in the previous four years.

The declines were partly engineered by the PBOC, which lowered its daily reference rate by 0.9 percent in the first half of 2014 to prevent the currency from becoming a one-way appreciation bet for speculators. The central bank allows the yuan to trade 2 percent either side of that daily rate.

Since then, the PBOC has raised the reference rate in each of the past five months, suggesting policy makers judged the declines had gone too far. The yuan was as much as 1.89 percent below the daily fixing set by the central bank on Monday, data compiled by Bloomberg show.

Capital Flight

Evidence of capital outflows shows how China is moving beyond using the reference rate to prop up the currency, and also reflects how money is leaving the nation as growth slows.

A key barometer of foreign-exchange flows on the central bank’s balance sheet, known as its yuan positions, fell 128.9 billion yuan ($21 billion) in December from a month earlier, the most since 2003, PBOC data show. China’s foreign-exchange reserves dropped to $3.84 trillion as of December, from an all-time high of $3.99 trillion in June.

These data “suggest there’s been net dollar demand in the onshore foreign-exchange market which the authorities have met,” Robert Minikin, the London-based head of Asian currency research at Standard Chartered Plc, said by phone on Jan. 21.

Trade Flows

Goldman Sachs Group Inc. says China’s official errors and omissions data -- figures used by nations to balance cross-border flows when records don’t match -- point to a record $63 billion leaving the country in the third quarter of 2014. Bank of America Corp. estimates $120 billion of capital flowed out of China in the final quarter of last year.

The PBOC didn’t respond to a fax seeking comment on outflows and its intervention policy.

Curbing the yuan’s losses has become critical since growth slowed to 7.4 percent last year, the worst performance since 1990.

In an address to Chinese economists today, Premier Li acknowledged the difficulties faced by the nation and said the authorities would adopt targeted measures to manage the economy and promote emerging industries.

The PBOC surprised investors by cutting interest rates in November for the first time since 2012 to give the world’s second-largest economy a lift, though that also reduces the return generated by yuan assets and undermines the currency.

The yield premium on China’s five-year government bonds over equivalent U.S. debt has narrowed to 2 percentage points, from 3.19 percentage points in November 2013, the widest difference in data compiled by Bloomberg since 2007.

Boosting Prestige

A stronger exchange rate would also boost the yuan’s prestige as China seeks to promote it as a currency of global commerce. In the past 12 months, the Asian nation has appointed yuan-clearing banks in cities from London and Frankfurt to Singapore.

An appreciating currency may also reassure U.S. officials who have accused the PBOC of debasing the yuan for economic advantage.

“If there are signs of significant depreciation pressure, the PBOC will intervene,” Kewei Yang, the head of Asia-Pacific rates strategy at Morgan Stanley in Hong Kong, said by phone on Jan. 16. “The risk of capital outflows weighs more in importance than temporary support for exports from a weak currency.”

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