Battered Yuan Posts Worst Year Since 1994 as HSBC Preaches Calm

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  • Top forecaster says weakness a result of new flexible policy
  • Offshore currency pares day's losses on suspected intervention

There’s no need to panic, according to the yuan’s top forecaster, even as the currency posted the biggest annual loss in more than two decades and a majority of economists predicted a further depreciation in 2016.

“While a weaker yuan could create fear initially, the market will realize it’s a natural consequence of a more flexible yuan and divergent U.S.-China monetary policy," said Ju Wang, a Hong Kong-based senior Asian currency strategist at HSBC Holdings Plc, which had the best estimates for the onshore yuan over the last four quarters as measured by Bloomberg Rankings. A more adjustable policy will allow for swift reactions to domestic conditions, which "would be structurally positive for China’s economy,” she said.

The nation overhauled its foreign-exchange system in 2015, giving market forces greater say in setting the yuan’s reference rate, allowing more foreign participants onshore and doubling trading hours. The central bank kept investors guessing as it supported the exchange rate from March to August, shocked global markets with an Aug. 11 devaluation, and then spent billions of dollars to prop up the yuan before winning reserve status at the International Monetary Fund on Nov. 30.

The currency tumbled 4.5 percent in 2015 to close at 6.4936 a dollar in Shanghai on Dec. 31, according to China Foreign Exchange Trade System prices. That’s the biggest decline in data going back to 1994. The central bank cut its daily fixing, which limits onshore moves to a maximum 2 percent on either side, by 6.1 percent for the year. The reduction was the most since 2005, when China unpegged its currency from the greenback and allowed it to fluctuate against a basket of exchange rates.

In Hong Kong’s market, which is free of the mainland’s capital controls, the yuan posted an unprecedented 5.3 percent loss for the year to 6.5704 on Dec. 31, according to data compiled by Bloomberg. The People’s Bank of China spread its influence to the city in 2015, taking the previously rare step of intervening offshore. The currency pared the day’s losses on Dec. 31 within a 10-minute period, spurring intervention speculation.

“It’s likely the PBOC intervened in the offshore market, considering the move was very quick and significant,” said Kenix Lai, a foreign-exchange analyst at Bank of East Asia Ltd. in Hong Kong. “The gap between the onshore and offshore yuan widened quite a bit in the past few days and heavy depreciation expectations will lead to capital outflows. A gap that’s above 1,000 pips will likely trigger intervention in the near term.”

The difference, which widened to 994 pips on Dec. 31 before narrowing to 768, increased to 1,200 points the previous day before suspected PBOC intervention strengthened the offshore exchange rate.

Capital Outflows

The August devaluation spurred capital outflows and drained $213 billion from the nation’s currency reserves as policy makers looked to control the yuan’s decline. Financial institutions including the central bank sold 221 billion yuan ($34 billion) of foreign exchange in November. A total of $508 billion of capital left China in the August-November period, according to a Bloomberg estimate that takes into account funds held in dollars by exporters and direct investment recipients. Exports declined for a fifth straight month.

The country will seek to increase the yuan’s convertibility in an orderly manner by 2020 and change the way it manages currency policy, according to the Communist Party’s plan for the next five years. The monetary authority, which has cut interest rates six times since November 2014 even as the Federal Reserve raised borrowing costs in December, will extend the onshore yuan’s trading hours to 11:30 p.m. in Shanghai effective Jan. 4.

Further Declines

"We forecast the yuan will weaken further as all the existing negative drivers remain in place -- from persistent risk of capital outflows and more monetary easing from the PBOC," said Koon How Heng, a foreign-exchange strategist at Credit Suisse AG’s private banking and wealth management unit in Singapore. "The yuan will likely drop gradually going forward, as the PBOC will likely seek to avoid a dramatic devaluation that leads to high volatility and risks destabilizing financial markets."

The yuan will decline 1.6 percent to 6.6 a dollar by the end of 2016, according to the median forecast in a Bloomberg survey. HSBC’s Wang expects the currency to reach 6.7, or a 3.1 percent drop, while Credit Suisse’s Heng sees a 4.5 percent retreat to 6.8.

“China won’t deliberately weaken its currency to gain trade competitiveness,” as a 3 percent depreciation won’t help exports significantly, said Wang. "Instead, the weaker yuan is driven by market supply and demand, when the currency is making the most remarkable transition to a market-oriented regime."

— With assistance by Tian Chen

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