China Casting Off Mao Shackles Burnishes Yuan Appeal: CurrenciesKyoungwha Kim and Fion Li
China’s planned economic reforms are burnishing the yuan’s credentials as a currency of global trade, pushing its offshore rate to the highest versus its domestic value in 10 months while damping volatility.
The yuan traded at a 0.47 percent premium in Hong Kong to its onshore price on Nov. 19, the most in 10 months and up from 0.29 percent last week, before the People’s Bank of China outlined plans to end daily currency intervention. A measure of implied volatility in the yuan fell, keeping it the lowest after Hong Kong’s dollar among 31 major peers tracked by Bloomberg.
The reforms are part of a once-in-a-generation attempt by China’s ruling Communist Party to modernize the economy, and follow measures encouraging use of the yuan outside the mainland. HSBC Holdings Plc predicts the currency, which climbed to a 20-year high last month, will be the main tender of international trade after the U.S. dollar and euro by 2015.
“Currency reforms need to exceed market expectations, or speculative forces behind the yuan will intensify one-way appreciation pressures,” Paul Mackel, the head of Asian currency research at HSBC in Hong Kong, wrote yesterday in a client note. “It’s hard to expect the yuan to continue growing in importance without it becoming more flexible.”
China will broaden the yuan’s daily trading band in an “orderly way” and accelerate moves to make it convertible with international currencies, PBOC Governor Zhou Xiaochuan said. Deputy Governor Yi Gang said yesterday “it’s no longer in China’s favor to accumulate foreign-exchange reserves,” adding to signs policy makers will rein in dollar purchases that limit the yuan’s appreciation.
The yuan rose 2.3 percent against the dollar this year, the most among 24 emerging-market currencies tracked by Bloomberg. It was pegged to the dollar until 2005, and now trades in a managed range against a basket of currencies, with different rates inside and outside of China.
The yuan’s onshore rate touched 6.0802 on Oct. 25, the highest since December 1993, before falling back to 6.0932 today, data compiled by Bloomberg show. The offshore price is at 6.0708. Non-deliverable 12-month forwards touched 6.1430 yesterday, matching the strongest level in Bloomberg data going back to 1998.
Other Chinese assets have also risen, with the Shanghai Stock Exchange Composite Index closing at the highest level in a month on Nov. 20, data compiled by Bloomberg show.
China’s central bank sets a daily reference rate for the yuan in Shanghai that the spot rate can diverge a maximum 1 percent from. The range was last widened in April 2012, after being expanded from 0.3 percent in May 2007.
“The eventual move to liberalize the currency market, interest rates and capital account are all works in progress,” Nizam Idris, the head of fixed-income and currency strategy at Macquarie Group Ltd. in Singapore, said in a phone interview yesterday. “As long as there’s a band in force, there’ll be a need to intervene. The measures are gradual and controlled.”
Idris said the range may be widened to 2 percent by June.
President Xi Jinping, who came to power in March, is accelerating the reform of economic policies that originated during or shortly after the reign of Chairman Mao Zedong, who died in his post in 1976. The changes, which the leadership say will be in effect by 2020, also include expanding farmers’ rights, allowing private investors to set up banks and loosening China’s one-child policy.
The changes are “China’s boldest reforms seen in decades,” Emmanuel Ng, an economist at Oversea-Chinese Banking Corp. in Singapore, wrote in a report yesterday.
Three years after the government allowed its currency to start trading in Hong Kong’s offshore market, international use of the yuan is increasing as China opens up.
About 17 percent of China’s global trade was settled in yuan in the first nine months of this year, compared with less than 1 percent in 2009, according to Deutsche Bank AG. The PBOC has arranged currency-swap lines with more than 20 overseas financial centers, including London and Frankfurt, encouraging greater use of the yuan for trade and finance.
Appetite for yuan-denominated assets is increasing after China’s economy expanded 7.8 percent in the three months through September, reversing a two-quarter slowdown. Manufacturing and exports rose more than economists projected last month, while inflation quickened to 3.2 percent from 3.1 percent in September, official reports showed.
Yuan positions at financial institutions accumulated from foreign-exchange sales, a measure of capital inflows, climbed 1.6 percent in October to 27.9 trillion yuan ($4.6 trillion), the highest in official data going back to 2000. Of 276 investors surveyed last week by Bank of America Corp., 39 percent said China was their favorite market.
“Increasingly investors are perceiving risks as relatively one-way toward a stronger yuan,” Greg Gibbs, a Singapore-based strategist at Royal Bank of Scotland Group Plc, wrote in a report yesterday.
Three-month implied volatility for the yuan plunged to 1.66 percent as of 1:52 p.m. in New York, from 1.89 percent on Nov. 19 and 1.85 percent before China announced the latest reforms, data compiled by Bloomberg show. The decline reflects investor expectations that the authorities will retain a hand on the tiller of China’s foreign-exchange market even as it continues to liberalize.
The nation will probably double the yuan’s trading band in either April or May before moving to a “managed-float” system, said Simon Derrick, the London-based chief currency strategist at Bank of New York Mellon Corp., the largest custody bank.
“We’re moving toward convertibility but there won’t be a hard change,” Derrick said in an interview in Singapore yesterday. “The People’s Bank of China will still be there managing the currency, but managing it in a far wider way.”