Getting the Yuan Right Means Ignoring What Chinese Leaders Say

  • Yuan drops against basket even as policy makers talk stability
  • `With the PBOC, one can never be sure,' says ANZ's Goh

Li Keqiang

Photographer: Qilai Shen/Bloomberg

When Chinese officials from Premier Li Keqiang to central bank Governor Zhou Xiaochuan all repeated the same message about the government’s yuan policy, Khoon Goh took them at their word.

That was a mistake.

QuickTake The People's Currency

Goh, the most accurate forecaster of Asian emerging-market currencies in 2015, has repeatedly lowered his predictions for the yuan against an index of 13 peers this year as the currency defied government pledges of “stability” against the basket. The strategist at Australia & New Zealand Banking Group Ltd. now says the yuan has further to fall after touching a 17-month low versus the gauge last week.

While policy makers have never defined exactly what they meant by stability, the disconnect between official rhetoric and the yuan’s path has undermined China’s efforts to repair investor confidence after a shock devaluation last August. With recent declines in the dollar easing concern over capital outflows, the People’s Bank of China may be content to allow yuan weakness against the basket to help the country’s beleaguered exporters.

“The authorities pledged stability against the basket, and I initially thought they showed full commitment,” Goh said from Singapore. “But that’s clearly not the case now. What we are seeing is continuous depreciation versus the basket. It shows that, with the PBOC, one can never be sure.”

China’s central bank faces a delicate balancing act with the yuan. While weakening the currency bolsters economic growth by making exporters more competitive, declines in the exchange rate could also exacerbate capital flight and erode consumer confidence. More than $900 billion left China in 2015 as the yuan dropped 4.4 percent against the dollar, the biggest annual slide since 1994.

As the world fretted over the yuan’s retreat versus the greenback last year, policy makers sought to refocus investors’ attention on the currency’s performance against a wider group of peers.

China Foreign Exchange Trade System, an arm of the PBOC that facilitates interbank currency trading, unveiled the 13-member CFETS RMB Index in December, while Premier Li said in a call with International Monetary Fund Managing Director Christine Lagarde in January that the yuan was stable against the basket and had no basis for depreciation. Zhou repeated that sentiment in a February interview with Caixin magazine, and PBOC Deputy Governor Yi Gang reiterated the stability pledge in March.

One-Way Bets

While the yuan has stabilized against the dollar -- rising about 0.2 percent this year -- it weakened 3.4 percent versus the basket to 97.44, according to a Bloomberg replica of the CFETS RMB Index. Levels below 98 would prompt traders to question the credibility of the government’s stability pledges, Credit Suisse Group AG strategists Ray Farris and Trang Thuy Le wrote in a note early this month. "It remains incredibly difficult to read the policy objective here," they said.

Of course, the PBOC has no control over global sentiment toward the dollar, which has soured in recent months as traders pared back expectations for Federal Reserve interest-rate increases. And keeping foreign-exchange traders guessing may be one of the PBOC’s objectives. The central bank, which didn’t respond to a fax seeking comment on Friday, has long sought to deter one-way bets on the yuan.

Currency War

Hu Yifan, chief China economist at UBS Wealth Management, offers another explanation for the yuan’s lack of stability against the CFETS index.

"The basket isn’t comprehensive or convincing enough at this stage to make the world accept it," Hu said from Hong Kong. "It is becoming less and less important. They’re phasing it out quietly and gradually."

The index’s weightings are based on the size of China’s trade with other nations, and the prices are taken from central bank reference rates, according to CFETS. The dollar has the largest weighting at 26.4 percent, followed by the euro and the yen at 21.4 percent and 14.7 percent, respectively.

Some analysts have flagged issues with the gauge’s composition. For instance, the currencies of South Korea and Taiwan, China’s fourth- and fifth-largest trading partners in March, are excluded. A more complete measure would consider the tender of trade receipts and China’s foreign debt structure, Hu said.

Banks and brokerages are reluctant to introduce products tied to the CFETS index because they aren’t sure how important it is to the PBOC’s currency policy, said Cliff Tan, east Asia head of global markets research at Bank of Tokyo-Mitsubishi UFJ Ltd.

For ANZ’s Goh, one risk of the yuan’s weakness against the basket is that other regional exporters will seek currency depreciation to protect their market share. When China devalued the yuan in a one-off move in August, it fueled speculation of a global currency war.

“I thought there was a floor back at 100, then 99, then 98” for the CFETS index, Goh said earlier this month. “If we get further declines, say toward 95-96, then this may start to raise some concern about how much China is allowing the yuan to depreciate, especially against other Asian currencies, and raise competitiveness issues.”

— With assistance by Justina Lee, and Tian Chen

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