Yuan Tumble Tests China’s Free-Market Resolve as PBOC Intervenes

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Yuan Tumble Tests China’s Free-Market Resolve

The yuan sank for a second day, spurring China’s central bank to intervene as the biggest rout since 1994 tested the government’s resolve to give market forces more sway in determining the exchange rate.


The currency slid as much as 2 percent to a four-year low of 6.4510 per dollar in Shanghai, before recouping about half its loss in the final 15 minutes of trading. While the People’s Bank of China followed through on a pledge to align its fixing more closely with the market rate, people familiar with the matter said authorities intervened to support the currency and told banks to limit some companies’ dollar purchases.

China’s surprise change to its currency regime is sending shockwaves through global markets, dragging down stocks and commodities as investors speculate the move was timed to combat a deepening slowdown in the world’s second-largest economy. That backdrop of weak growth is complicating policy makers’ efforts to maintain financial stability while they loosen the state’s grip on markets and push for reserve-currency status at the International Monetary Fund.

The yuan is facing “a vicious cycle of depreciation,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. “At some point they’ll either abandon the implementation of the new fixing mechanism and stabilize the fixing, or they’ll intervene heavily.”

New Method

The PBOC’s daily fixing for the yuan fell by 1.6 percent on Wednesday, after a 1.9 percent cut on Tuesday. Under the new methodology, market makers who submit contributing prices have to consider the previous day’s close, foreign-exchange demand and supply, as well as changes in major currency rates.

The onshore yuan fell Wednesday to as much as 1.9 percent weaker than the fixing, near the 2 percent limit of its permitted daily trading range, even as the PBOC intervened to support the currency via banks around midday local time.

It subsequently rebounded, including a 0.8 percent advance in the final minutes of trading, as at least one major state lender sold a large amount of dollars, according to two traders familiar with the matter. Entering the market to influence the yuan’s closing level would allow authorities to guide the next day’s reference rate.

“Intervention is the new tool as they’ve relinquished some control over the fixing,” said Jason Daw, head of Asia currency strategy at Societe Generale AG in Singapore. “Intraday intervention could become a more frequent occurrence in the market given that they’ve changed the currency regime.”

‘Normal’ Fluctuations

The PBOC said earlier that current fluctuations are “normal” and that its daily fixings will “gradually move towards stability.” It reiterated that the currency will be kept basically stable, highlighting the nation’s trade surplus and $3.65 trillion of foreign-exchange reserves. The central bank didn’t immediately reply to a fax seeking comment on whether it had intervened.

The State Administration of Foreign Exchange issued notices to banks on Wednesday, asking them to limit dollar purchases by some companies that may have been arbitraging the gap between onshore and offshore yuan rates, according to people familiar with the matter.

The swings in the yuan over the past two days are “within a controllable range,” PBOC Chief Economist Ma Jun said in an interview cited on Yicai.com.

“The PBOC is fully capable of directly intervening when necessary in the foreign-exchange market to stabilize the market rate and to prevent exchange-rate fluctuations caused by irrational herd behavior,” Ma said.

Old Ways

The yuan was trading at 6.5442 per dollar late Wednesday in Hong Kong’s offshore market, where it is freely exchangeable. That level was 2.4 percent weaker than the Shanghai close of

6.3870, the biggest discount since the yuan began trading outside of the mainland in 2010. The gap was 0.1 percent on Monday, before the surprise devaluation.

If the yuan drops too quickly, the PBOC could be forced to return to its old method of setting the fixing closer to where it wants the currency to trade, said Zhang Ming, director of international investment research at the Chinese Academy of Social Sciences in Beijing. That’s cheaper than using foreign-exchange reserves to influence the market, he added.

Tuesday’s devaluation suggests policy makers are now placing a greater emphasis on supporting exports after overseas shipments declined the most in four months in July. In recent months, authorities had been propping up the yuan to deter capital outflows, protect foreign-currency borrowers and encourage greater global usage as they intensified the campaign for entry into the IMF’s reserves basket.

Investor Shock

China’s new mechanism to calculate the daily fixing should allow market forces a greater role and facilitate operation of the reserves basket were the yuan to be included, the IMF said in a statement. The agency’s staff recently proposed delaying the basket’s expansion to September 2016, which would give China more time to implement policy changes.

Tuesday’s move jolted investors who had grown accustomed to the yuan’s de facto peg of 6.20 over the last four months.

“It was very shocking,” said Stella Lee, the president of Success Wealth Management Ltd. in Hong Kong. She’s planning a trip across the border to Shenzhen on Saturday to bring her personal yuan deposits back into Hong Kong on concern the yuan will depreciate further.

Asian currencies tumbled amid concern a weaker yuan will reignite a currency war. South Korea’s won, Malaysia’s ringgit and Indonesia’s rupiah all declined at least 1 percent against the dollar. The Bloomberg-JPMorgan Asia Dollar Index fell as much as 1.3 percent to a six-year low. Vietnam cited the PBOC’s action as it widened the trading band on its own currency on Wednesday.

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“A weak fixing two days in a row does not help stabilize sentiment, commodity currencies and Asian currencies,” said Roy Teo, a strategist at ABN Amro Group NV in Singapore. “There should be some stabilization in terms of the yuan fix because they wouldn’t want to invite speculators or to let the market think that the direction in the currency is a one-way bet.”