July 19, 2018 / 4:20 AM / 10 months ago

Breakingviews - China's commitment to stable yuan looks unstable

FILE PHOTO: A Chinese yuan sign (L) and a dollar sign are printed on an ATM machine inside the Bank of China Tower in Hong Kong, China November 12, 2015. REUTERS/Bobby Yip/File Photo

HONG KONG (Reuters Breakingviews) - China’s commitment to a stable yuan looks unstable. The currency moved below 6.7 to the dollar this week, a level recently defended by state banks. That reflects a greenback rally and cooling Chinese growth, not the export weapon many investors fear. As Beijing warms to monetary easing, though, lines in the forex sand will blow away quickly.

    Amid ever-greater tariffs being imposed by the United States on Chinese goods, concerns are rising that Beijing could deliberately devalue its currency to help neutralise the effect. That would drop a giant currency bomb into the trade war.

    If the People’s Bank of China wants to get aggressive, all it need do is sharply revalue its daily rate guidance. Onshore traders can only quote 2 percent above or below the midpoint of the range, so a steep adjustment automatically depreciates the market rate. In 2015, the central bank did just that, and scared the bejesus out of nearly everyone.

    There are good reasons to refrain this time. Exports are no longer the primary driver of growth. Depreciation encourages capital flight, increases the cost of energy imports and depresses consumption.

    Instead, it seems the PBOC is managing a controlled slide. Local traders watch for any moves to slow intense rallies or crashes, usually via giant state banks, which can dictate market rates by buying or selling yuan. It happened on July 3 after the currency crossed 6.7 per dollar in intra-day trade, Reuters reported. Two days later chief bank regulator Guo Shuqing said there was no chance of sharp yuan depreciation, and warned against shorting the currency.

    The dollar keeps strengthening, though, and Chinese officials appear to be preparing to further ease monetary conditions. The PBOC has been ordering banks to lend more actively and buy more bonds. The government has repeatedly released cash into the system this year by reducing bank reserve requirements, and will do so again. The net effect is a wider yield gap between U.S. Treasuries and local debt, making yuan-denominated assets even less attractive.

    In this context, the PBOC could not plausibly induce the 6.7 line to hold. There’s no point in defending the indefensible, but this retreat happened quickly. Insiders told Reuters the next stop is 6.9. It may get tested soon.


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