Barclays Says Sharp Yuan Devaluation Needed to Shift Psychologyby
Says might have to be as large as 25 percent to stem outflows
FX reserves may fall below `comfort levels' in 6 to 12 months
A sharp, one-off devaluation of the yuan is among options China’s central bank might consider to stem capital outflows and shift market psychology to appreciation from depreciation, according to Barclays Plc.
The risk of such a move, which Barclays says would need to be in the region of 25 percent to alter perceptions, is rising as China’s foreign-exchange reserves plunge, analysts Ajay Rajadhyaksha and Jian Chang wrote in a report. Based on the current pace of decline in those holdings, there’s a six- to 12-month window before they drop to uncomfortable levels and measures such as capital controls or monetary tightening may also have to be looked at to curb the exodus of money, they said.
All those options carry elements of danger. Another rapid yuan depreciation could spook investors just as concern about the state of the global economy is growing and other central banks would likely follow, countering the beneficial impact on Chinese exports, the analysts said. Strict capital controls won’t work in an export-driven economy, while a move to policy tightening could slow growth and cause credit defaults, they said.
“A devaluation of this magnitude seems impossible to ‘sell’ to the rest of the world," according to the analysts at Barclays, the London-based bank ranked the world’s third-biggest currency trader by Euromoney. “The People’s Bank of China will probably have to take more aggressive measures to stem outflows," said head of macro research Rajadhyaksha in New York and Hong Kong-based chief China economist Chang.
The yuan has dropped 2 percent since China won reserve-currency status at the International Monetary Fund at the end of November to 6.5279 a dollar as of 3:19 p.m. in Shanghai, according to China Foreign Exchange System prices. A surprise devaluation last August created financial turmoil in world markets and sparked speculation of a global currency war.
Chinese policy makers are trying to counter record outflows and prop up the yuan, while opening up the capital account and keeping borrowing costs low to revive growth in the world’s second-biggest economy. The balancing act challenges Nobel-winning economist Robert Mundell’s “impossible trinity” principle, which stipulates a country can’t maintain independent monetary policy, a fixed exchange rate and free capital borders all at the same time.
The People’s Bank of China reported a $99.47 billion drop in its foreign-exchange reserves to $3.2 trillion for last month, less than December’s record $107.9 billion decline. A safe level would be $2-$2.75 trillion, according to Barclays’s estimate using IMF standards. Societe Generale SA also said this month China will have to step up capital controls to stem the outflows.
“The only reason for a one-off devaluation is to use it as a way to stem capital flight -- in which case, it has to be a large move," the report from Barclays said. “No matter what it decides, the outcome carries significant risks for global financial markets."