A man walks past an advertisement promoting exchange services centered on the Chinese renminbi, U.S. dollar and euro at a foreign-exchange dealer in Hong Kong, Aug. 13, 2015. Photo: Reuters
China’s financial system is “largely stable and healthy,” the country’s foreign exchange regulator said at the weekend in an effort to reassure global markets as investors braced for a possible resumption of last week’s market turmoil.
Attention is likely to focus on China’s central bank and its management of the renminbi this week, after the markets regulator appeared to stabilise last week’s stock sell-off by scrapping a controversial “circuit breaker” mechanism and extending a ban on share sales by large shareholders.
The renminbi fell 1.5 per cent against the dollar in onshore trading last week to Rmb6.59 — a sharp move for the carefully managed currency. Traders have largely ignored the central bank’s guidance that they should focus on the renminbi’s stability against a basket of 13 currencies rather than volatility against the dollar.
Offshore the renminbi fell 1.7 per cent against the dollar to Rmb6.68, widening the spread between the two rates to a record level. The gap implies that international investors are pricing in further weakening of the onshore rate. Before the People’s Bank of China unexpectedly devalued the currency in August, the two rates traded at virtually the same level.
More recently, the PBoC has been letting the onshore rate weaken and intervening in the offshore market to limit the gap. Separately, the State Administration of Foreign Exchange (Safe) has been scrutinising banks that help clients arbitrage between the two – a move that some critics feel is inconsistent with the International Monetary Fund’s recent designation of the renminbi as an official reserve currency under its special drawing rights (SDR) regime.
“We seem to be drifting back into a two-tiered [renminbi] system and that is worrying,” said one investment strategist, who asked not to be named.
“How can you be in the SDR and yet you penalise banks for arbitraging between the two rates?” he added. “It’s outrageous and wrong. They shouldn’t be in the SDR and doing that. They should be making sure they continue liberalising to unify the two rates.”
The IMF identified the rising spread between the onshore and offshore RMB rates as an “operational challenge” when it decided in November to include the currency in the basket used to value its special drawing rights from October 1 this year. But it also argued that reforms underway would eventually allow “unencumbered” access to China’s onshore markets. Any moves to restrict that access so soon after its big vote of confidence in Beijing and China’s reform path would be potentially embarrassing for the IMF.
In a statement at the weekend, Safe tried to reassure investors. “China’s economic fundamentals are strong,” the regulator said. “Foreign exchange reserves are relatively abundant and the financial system is largely stable and healthy.”
The PBoC last week blamed “speculative forces” for the renminbi’s recent weakness against the dollar. Last month, China’s foreign exchange reserves fell by a record $108bn — a number that reflects rising capital outflows as well as the cost of intervention.
“Investors should not expect the authorities to keep running down the reserves to keep the [renminbi] stable indefinitely against the dollar,” Mansoor Mohi-uddin, a market strategist with RBS in Singapore, wrote in a research note on Saturday.
Over the past 12 months, China’s forex reserves have fallen by more than $500bn, although many analysts argue that this is not a concern as the country currently holds far more reserves than comparable economies and can afford to let them run down further.
“Another few months of this and China would have burnt through over one-third of its peak reserve level in defending its currency since July 2014,” Miranda Carr, an analyst at Haitong Securities, wrote at the weekend.
She added: “So far China in 2016 appears to be everyone’s worse nightmare come true.”