China’s central bank is effectively anchoring the yuan to the US dollar, a policy twist that has helped stabilise the currency in a year of political transition and market jitters about China’s economic management.
The yuan weakened more than 6 per cent against the greenback in 2016; this year, it is up roughly 1 per cent, and the expectation that the currency will fluctuate — a gauge known as implied volatility — is around its lowest in nearly two years.
The new-found tranquillity may not last: the focus seen in recent weeks on stability against the US currency, whether it goes up or down, means pressure on the yuan to weaken could get dangerously bottled up, potentially bring bouts of sharp devaluation.
On Wednesday, Moody’s Investors Service cut China’s sovereign credit rating, citing the peril of rising debt as growth slows. The effort to keep up with the US dollar could add to the challenge by forcing the central bank to keep burning through its forex reserves to support the yuan.
How China manages its currency is one of the most consequential decisions in global financial markets — and one that remains largely inscrutable to investors. As Beijing tackles a huge build-up of corporate debt, many investors worry the process could create more risk and even set off a financial crisis.
While recent regulatory efforts aimed at curbing debt have rattled Chinese markets for stocks and bonds, the country’s currency market has been relatively calm.
The People’s Bank of China’s previous strategy was to let the yuan track the US dollar when the US currency weakened — part of a tactic to guide the currency steadily lower but keep it from falling too fast. When the US dollar strengthened, the central bank shifted the yuan’s “fix” instead to a basket of currencies.
With tempering the currency volatility against the US dollar now a bigger priority, the yuan has been propped up even as the US dollar rises. A case in point: early Wednesday, the yuan’s official value came in at 6.8758 a US dollar, much firmer than the markets’ expectation for 6.9 per US dollar and only slightly weaker than the previous fixing.
A day later, after the Moody’s downgrade, the PBOC again fixed the yuan stronger than expectations, and traders say some big Chinese banks sold US dollars in early trading to bolster the yuan.
The close alignment with the US dollar could ease the threat of a trade war with the US, after President Donald Trump claimed China has exploited weakness in the currency at the expense of its trading partners. Mr Trump recently refrained from labelling China a currency manipulator.
“China’s management of its currency has changed significantly in the wake of the US election, with the renminbi (yuan) essentially repegging against the US dollar,” said Robin Brooks, a former Wall Street currency strategist and now chief economist at the Institute of International Finance. “The repeg could be quite sticky and only a major surprise has the potential to dislodge the exchange rate.”
A study by Mr Brooks and Gene Ma, China economist at the institute, concludes that the central bank has moved away from a rule-based method of fixing the yuan and is exerting more “discretion” over the exchange rate.
The steadier yuan, coupled with more restrictions on money leaving China and higher interest rates, has calmed investors and helped keep money onshore. A resurgent US dollar, driven by more US interest-rate increases, could make it much costlier for China to maintain the anchor to the US dollar, potentially hurting Chinese exporters’ competitiveness. That would drag down growth further and add to economic headwinds at home.
Meanwhile, the PBOC is letting the yuan slide against currencies of its other trading partners, like the Korean won and the Japanese yen. An index of the yuan’s value against a basket of currencies fell to its lowest level on yesterday since it was first published by the central bank in 2015. That helps give Chinese exporters a leg up in those markets.
“It’s depreciation by stealth,” said Ashley Perrott, head of pan-Asian fixed income at UBS Asset Management in Singapore.
By LINGLING WEI, SAUMYA VAISHAMPAYAN
The Wall Street Journal