Yuan Seen Needing Bigger Depreciation for China to Reap Benefits

  • Currency must fall another 14% to spur 0.7 points of growth
  • Risk is that debasing the yuan can lead to capital outflows

What's Driving the Chinese Currency?

The yuan, which has fallen 5 percent since China’s central bank devalued the currency in August, probably needs to fall an additional 14 percent if the nation’s economy is to see any real benefits.

A decline to 7.7 per dollar, from about 6.6, is needed to boost gross domestic product expansion by 0.7 percentage point, according to estimates by Bloomberg Intelligence Economics. The move, a scenario which none of the analysts in Bloomberg surveys expects, would lead to $670 billion in capital outflows.

The trick for Chinese officials is to manage the currency lower without sparking a mass exodus of capital from the country. The drop in China’s exports is mainly the result of sluggish global demand, and the collapse of the yuan would only increase the risk of competitive devaluations in neighboring countries -- creating a so-called currency war.

“They don’t want an excessive devaluation,” said Sacha Tihanyi, senior emerging-markets strategist at Toronto Dominion Bank in New York. “I don’t think they’re trying to achieve some kind of export advantage through currency devaluation.”

The yuan slid to a five-year low of 6.5956 per dollar in Shanghai on Thursday after the central bank cut the fixing, extending its decline over the past year to 5.7 percent. The People’s Bank of China halted an eight-day run of cuts to its reference rate for the currency on Friday, leaving the offshore exchange rate little changed at 6.6840 per dollar as of 6:46 a.m. New York time.

The gap with the onshore level was at 1.4 percent. It widened to a record 2.9 percent on Thursday before tightening amid suspected intervention.

Exports Decline

China’s exports fell for a fifth month in November, the customs administration said at the end of last year. Gross domestic product growth will slow from 6.9 percent in 2015 to 6.5 percent this year, according to a Bloomberg survey.

To lift export growth by 10 percent this year would require a 13 percent drop in the yuan on a trade-weighted basis, the historical relationship between the two suggests, according to Bloomberg Intelligence analysts Fielding Chen and Tom Orlik. That implies that the yuan needs to decline to about 7.7 per dollar, which would be the lowest since 2007. Option traders assigned a 13 percent probability of reaching it this year.

Only one analyst among 64 surveyed by Bloomberg expects the yuan to weaken beyond 7 per dollar this year. Analysts at Rabobank Group of the Netherlands are the most bearish, predicting the yuan will weaken to 7.6 per dollar by the end of December. That compares with the median forecast of 6.65 per dollar.

Mixed Signals

The People’s Bank of China has sent mixed signals about the goals of its currency policy. The authorities have repeatedly pledged to keep the yuan stable, drawing down a record $513 billion from foreign reserves last year to shore up the exchange rate. At the same time, the PBOC set its reference rate at unexpectedly weak levels this week, raising speculation that it’s become more tolerant of depreciation and rattling global markets.

Analysts at JPMorgan Chase & Co. lowered their year-end yuan forecasts Thursday to 6.9 per dollar, from 6.7, saying the weaker fixings were a “clear confirmation of a shift in the mindset of Chinese authorities” in favor of a weaker yuan versus the dollar.

Economic Improvements

The currency decline is at odds with recent signs of economic stability. Monthly indicators due Jan. 19 are poised to show continued gains in retail sales, and some acceleration in industrial output from November to December, according to Goldman Sachs Group Inc. Evidence also indicates that house prices are steadying, metals prices have picked up from historical lows and demand for credit is reemerging.

While exports are slowing, they’re more or less in line with other nations as global trade stagnates. Overseas shipment in China fell 6.8 percent in November, compared with a 6.3 percent drop in Taiwan and a 4.8 percent decline in South Korea.

If anything, Chinese exporters are edging out their competitors, hardly a sign of currency overvaluation. The country’s share of global exports surged to about 14 percent in July, from 8.7 percent in January 2010, according to data compiled by Bloomberg.

Further depreciation fuels expectations of more weakness and capital outflows, according to Chris Turner, London-based head of currency strategy at ING Groep NV. Outflows amounted to almost $1 trillion in the year through November, according to Bloomberg data.

“The PBOC want to keep it ‘basically stable’ against a basket of currencies,” said Turner. Losing control of the yuan “could trigger more capital outflows” and that would be their main concern, he said.

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