China faces more challenges in keeping yuan stable

Chinese 100 yuan notes in Beijing. Photo: Getty Images

The Chinese government may face more challenges in preventing its currency, the yuan, from further depreciation against the US dollar amid a possible slowdown in economic growth, after it announced a series of policies earlier this year to curb capital outflows, market participants said recently.

At the start of 2017, China tightened its foreign exchange purchase policies by requiring Chinese residents who want to buy US dollars to fill a detailed application form indicating their purposes of buying. Such purchases cannot be used for overseas investments on properties, securities as well as insurance products, and are now under a stricter scrutiny, although the $50,000 annual individual exchange quota remains unchanged.

“The policy could help to curb capital outflows and ease the pressure of yuan’s further depreciation,” said Yu Yongding, a scholar at the China Academy of Social Sciences and a former central bank adviser.

China’s yuan dropped nearly 7% against the US dollar in 2016 as expectations of US Fed’s rate hike grew. Such expectations intensified after the win of President-elect Donald Trump, whose fiscal and economic policies are seen to be in favor of more rate hikes.

China’s foreign exchange reserves totaled US$3.01 trillion in December 2016, falling $319.8 billion on year, according to data from the State Administration of Foreign Exchange. The SAFE said the decline was mainly due to the central bank’s efforts to stabilize the yuan in the past year.

Analysts expected the yuan’s depreciation pressure to continue to weigh on the government’s policies in 2017 amid a continued slowdown in economic growth and capital outflow pressure.

“The economic growth rate in 2017 may be slower than that in 2016, probably between 6% and 6.5%, but the growth will be stable and there will not be a hard landing,” Yu said.

Under the expectations of yuan’s further depreciation, retail investors who are eager to maintain the value of their assets, transferred their capital abroad, and such moves quickly triggered a wide effect on the market, said analysts.

“Once there is such an effect on the market, there would be (more) pressure on the yuan and (lead to more) capital outflows,” said Chen Naixing, a researcher with Chinese Academy of Social Science.

Analysts said that capital outflows could further push the central bank to support the yuan by exhausting foreign exchange reserves, which might affect the government’s ability to stabilize the exchange rate and finally threaten the nation’s financial safety.

Such examples can be found in other countries, according to Philippe Metoudi, a Hong-Kong based investment banker.

A tremendous amount of money fled France in 1981, mostly to Switzerland and Luxembourg when the first socialist French president, Francois Mitterand was elected to office. The capital outflows put tremendous pressure on the Franc that forced the central bank to devalue the currency several times and it took years for the country to recover from these events. More recently, in Venezuela, massive capital outflows have seriously damaged the country’s economy. Metoudi said China’s authorities have proved to be pragmatic in tackling such issues.

Yuan’s fall to weigh on Chinese economy

Yuan’s further depreciation would harm the Chinese economy by pushing up the country’s inflation, and dampen the confidence in the yuan and thus the investment interest in China, said analysts.

“If yuan depreciates sharply, it will have a great impact on companies which have bought large amount of foreign debt,” said Sean Xiao, an independent economist specialized in currency.

As China is a large importer of bulk commodities in the world, a sharp fall in its currency may also push the prices of imported goods up, which could lead to a rise in its local consumer price index, he added.

However, China may not have much leeway in intervening in yuan’s exchange rate besides the use of foreign exchange reserves and capital outflow controls, said Yu.

China needs to maintain its foreign exchange reserves at a reasonable level, while too much curb on capital outflows could be negative to the country’s prestige and affect its overseas investment, he added.

Besides SAFE’s tighter control on Chinese residents’ capital outflow, the China Foreign Exchange Trade System also adjusted the number of currencies in the CFETS basket from January 1 by adding 11 more currencies to the basket and reducing the weight of the US dollar from 26.4% to 22.4%.

Through such a move, the government is trying to reduce the dollar’s impact on the yuan and sending the market a signal that the yuan’s exchange rate will be linked to a broader range of currencies instead of just the US dollar so as to relieve the devaluation pressure on the yuan, according to Chen.

Mei Xinyu, an associate research fellow with the Ministry of Commerce, said in an interview with that “it may take another one or two years” before the trend of the yuan depreciation could be reversed.

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