August 11, 2016 — 7:00 AM AEST Updated on August 11, 2016 — 7:25 PM AEST
The foremost watchers of China’s yuan say stability is coming at a cost.
After a year defined by last August’s shock devaluation and a string of surprise yuan fixings in January, officials have reined in volatility by tightening capital controls and increasing intervention. While the measures eased outflow pressures, they also showed policy makers are willing to push back ambitions for the yuan to be an international currency.
With the yuan just weeks away from inclusion in the International Monetary Fund’s basket of reserve currencies, Royal Bank of Canada says China has slowed the pace of reforms needed to make it more freely traded. The currency’s share of worldwide payments has dropped to a two-year low and its persistent depreciation has reduced its appeal as an alternative to the dollar, with deposits dwindling in the biggest offshore hub of Hong Kong.
"There may come a time in the future when liberlization of the capital account and aspiring to have a reserve currency will be viable and possible, but now is not the time because we have more pressing issues than liberlization," said George Magnus, London-based senior independent economic adviser to UBS Group AG." For the moment, I think it's stability at all costs."
While the 1.9 percent one-time devaluation a year ago was aimed at making the yuan more market-driven, the move took global traders by surprise and fuelled speculation authorities were intent on driving the currency lower to boost flagging exports. Coming on the heels of a botched stock-market rescue, the lack of clarity over the shift added to criticism about Chinese regulators’ handling of the nation’s financial markets, and sent volatility in the yuan to a record high on Aug. 13. 2015
As outflows accelerated to reach $1 trillion in 2015, the government stepped up scrutiny of cross-border transactions and froze quotas for a program that lets individuals invest abroad. The central bank’s new system for determining the yuan’s fixing -- which limits currency moves to 2 percent on either side -- also appeared flexible. In the days following the yuan’s plunge in August and January, the reference rate hardly moved for at least a week despite sizable swings in global foreign-exchange markets. Late last month, the PBOC appeared to defend the yuan from falling past 6.7 per dollar with stronger-than-expected fixings, according to RBC and Scotiabank.
"There is still a lack of clarity about the precise nature of China’s exchange rate policy," said Sue Trinh, RBC’s Hong Kong-based head of Asian foreign-exchange strategy, who was bearish on the currency before last August’s plunge. "These things take time and require consistency."
Such heavy-handed measures are limiting the effectiveness of steps to broaden the global appeal of the yuan, including increased overseas access to onshore markets and extended currency trading hours. The yuan’s share of global payments dropped to 1.7 percent in June, ranking the currency sixth. It’s due to become the first emerging-market currency to enter the IMF’s Special Drawing Rights on Oct. 1. 2015.
"Yuan internationalization was built on an unsustainable, weak foundation," said Yu Yongding, a former adviser to the PBOC, adding that it had depended on appreciation bets. "As China’s monetary authority has many qualms about letting the yuan free float and the conditions aren’t there for the yuan to be fully convertible under the capital account, it’s inevitable that yuan internationalization should run into obstacles."
The PBOC said in its 2016 report on yuan internationalization released Thursday that it will give markets a bigger role in setting the yuan’s rate, keep it basically stable and further expand its cross-border use under the current account.
There is little sign now of the panic that beset China’s currency market last summer and at the start of this year. While the yuan has continued to decline, both against the dollar and a basket of trading partners, option traders are the least bearish on the currency in almost two years, outflows have slowed and a gauge of volatility has declined to its lowest level since November. The Chinese currency was little changed Thursday at 6.6396 against the greenback.
"To be a proper reserve currency, free cross-border flows are important," said He Xin, head of China trading at Societe Generale SA in Shanghai. "At the same time, stable financial markets are also what international investors need."
For the yuan to have a bigger global presence, foreign nations will have to accumulate yuan assets. That means China will have to run its current-account surplus down to a deficit or open its capital account -- steps the country is probably unwilling to take, according to Magnus.
There are signs opening the capital account has become less of a priority to China’s leadership. In his annual report to legislators in March, Premier Li Keqiang shied away from saying the nation will increase the yuan’s two-way flexibility and boost capital-account convertibility, departing from language used in the work report at last year’s National People’s Congress.
"When a central bank moves toward a new exchange rate regime, it will necessarily introduce some volatility, but that is how market participants learn to hedge new volatility, which eventually will bring about stability," said Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance. "However, the leadership seems completely intolerant even of such transitory volatility."
— With assistance by Justina Lee, and Tian Chen