The surge in the Chinese Yuan in 2017 has erased all of last year’s losses. The trend reversal happened on the back of easing global risk aversion, lower worries of a China economy hard landing and improved global economic outlook.
The rise in Yuan has led to a sharp rise in China’s fx reserves and this has prompted the PBoC to relax controls on capital. The latest lifting of restrictive measures on foreign exchange hedging and yuan deposits on China’s mainland suggested that the authorities have started to worry about the rapidly appreciating yuan. Chinese yuan has appreciated by 6.97% against the USD so far in year 2017, reversing all of last year’s record loss of 6.5% and putting the currency on pace for its best year ever.
On 8th September 2017, the People’s Bank of China dropped a requirement that raised the cost of using currency forwards to bet on renminbi depreciation. The rule was implemented two year back. In a ruling, the People’s Bank of China (PBOC) scrapped reserve requirements of 20% for financial institutions to settle foreign exchange forward yuan positions while it lifted requirements for foreign banks to put aside reserves for offshore yuan deposits in China.
By making yuan forwards cheaper to trade, the policy is likely to stimulate importers to increase hedging, while allowing speculators to short-sell the currency. The policy may also act as a catalyst to attract new inflows into China’s onshore bond market from foreign investors. International investors’ buying of Chinese debt slowed in August, reflecting lingering concerns over the Bond Connect scheme partly because of the lack of hedging instruments available to foreigners to manage currency risks.
Yuan – Chronology of Events
The Renminbi (Yuan) has fallen to multi year lows in 2016 post Trump victory on the US Presidential Elections on the 8th of November 2016. The fall in the Yuan was sparked off by expectations of Trump embarking on a trade standoff with China. China has also been devaluing the currency to improve its exports that has grown sharply and also to limit the capital flows coming in through interest rate arbitrage on the back of a seemingly strong currency.
Trump victory fall in the Yuan was good for China as its exports become competitive and the Central Bank does not have problems of managing excess liquidity on fx buying that caused over lending, over investments and asset price bubbles.China’s foreign exchange reserves have risen for seven straight months since hitting a three-year low in January.
Offshore Chinese Yuan on 23rd November 2016 touched record low levels of CNY 6.9543 and Onshore Yuan was trading at multiyear low levels against the USD largely due to the broad strength in the USD at that time , which is trading at multi year high levels against major world currencies post Trump presidential election victory.
6th January 2016
China set the Yuan (CNY) also known as the Renminbi (RMB) reference rate to the USD at levels of Rs 6.5646, down 0.51% from the previous day’s fix, the sharpest decline since August 2015 and the lowest mid-point since 2011. The lower Yuan fix increased volatility in global equity, currency and bond markets. The Yuan was further pressured when the country’s fx reserves data for December 2015 was released. The data showed that China’s fx reserves fell by USD 107 billion taking 2015 fall to USD 600 billion. China’s fx reserves declined from USD 3.9 trillion to USD 3.3 trillion.
11th August 2015
China shocked global markets by lowering the reference rate of the Yuan against the USD by 1.9%, the biggest one day drop since 1994, when the country ended its dual currency peg. China set the reference rate at CNY 6.2298 to the USD. Global equities, currency and bonds saw sharp volatility on China devaluation.
The Yuan and Global Markets
China has an Offshore and Onshore currency. The offshore currency is freely traded in major global markets while the onshore currency is a managed float. The offshore currency has become a USD 2 trillion market over the last few years as global investors took advantage of the free float nature of the currency to invest in a seemingly non depreciating Yuan. The sharp flows into Yuan assets drove China’s foreign exchange reserves to USD 3.9 trillion from USD 1.9 trillion in the 2009 to 2014 period. Chart 2 and Chart 3 shows how a strengthening Yuan drove capital flows and increased fx reserves.
The year 2015 saw a change in the outlook for the Yuan. China’s exports were falling continuously on weak global demand Chart 1, and GDP growth was coming off Chart 6. China’s move to devalue the Yuan to make its exports competitive led to almost USD 2.5 trillion of global capital at risk. Capital outflows in 2015 is estimated at close to USD 1 trillion.
China Yuan devaluation has placed huge pressure on commodity markets as the country was the largest consumer of commodities. Chart 6 shows the strong correlation between China’s GDP growth and global commodity prices as measured by the Reuters CRB Index. The fall in commodity prices has impacted global GDP growth negatively with World Bank lowering global growth forecast for 2016.
China is driving global economies and markets and its management of its currency will be the key focus for markets going forward.
Yuan – Chronology of the Currency
China commenced its transition to a global powerhouse in 1978, as Deng Xiaoping ushered in sweeping economic reforms. In the three decades from 1980 to 2010, China achieved GDP growth averaging 10%. The Chinese economy grew five-fold in USD terms from 2003 to 2013, and at USD 9.4 trillion, it is the world’s second-largest economy at present.
China’s rapid growth since the 1980s has been fueled by massive exports. A significant chunk of these exports goes to the U.S., which overtook the European Union in 2012, which was earlier China’s largest export market. There was a tremendous expansion in economic ties between the U.S. and China after China’s entry into the World Trade Organization in 2001.
Chinese economy’s heavy dependency on export has forced the policymakers in China to peg the Yuan against the USD. The countries that peg their currency against the USD are typically export driven economies where an artificially held currency value helps to maintain their exportslevels. Most of the oil exporting countries in the Middle East have pegged their currencies to the USD. Hong Kong is a prominent economy that has pegged its currency to the USD.
The Yuan’s Timeline gives an idea of how the currency has evolved over the years
U.S. Treasury labels China a currency manipulator in a report to Congress. China is kept on the list in September 1993 and July 1994.
China in 1980s and early ’90s operated two distinct and highly divergent exchange rates. There was an overvalued official rate and a market rate set by foreign and domestic businesses trading in currency swap centers.
Back then, there were also two types of Chinese currency. Foreigners weren’t allowed to own Renminbi. So travelers were supposed to exchange their hard currency for Foreign Exchange Certificates at the Bank of China.
China unifies its dual exchange-rate system by moving the official rate of CNY 5.8 to the dollar to the prevailing market-determined rate of CNY 8.7, devaluing the Yuan by 33% overnight as part of reforms to establish a socialist market economy. The new “controlled floating-rate system” lets the Yuan move in the market within a narrow government-determined range.
China allows the Yuan to be fully convertible into foreign currencies for trade purposes but maintains rules and limits on buying and selling foreign currencies to make loans and investments.
The U.S., Japan and other countries urge China not to devalue the Yuan during the Asian financial crisis, fearing it could trigger a chain reaction. China wins praise for sticking to its commitment not to devalue the Yuan during the Asian financial crisis and helping to stabilize the region. The Yuan is pegged at CNY 8.28 to the dollar through frequent central-bank interventions.
China begins to relax its capital controls gradually after joining the World Trade Organization in 2001, but international pressure mounts for China to let the Yuan appreciate faster to help balance global trade.
In July 2005, China shifts from a decade-old peg against the dollar to a managed float, based on a basket of currencies. It revalues the Yuan by 2.1% overnight to CNY 8.11 against the dollar.
The first Yuan-denominated bonds are sold in Hong Kong.
China effectively pegs the Yuan against the dollar at CNY 6.83 as an emergency measure to help stabilize China’s economy amid the worsening global financial and economic crisis.
In June 2010, China ends a two-year long peg to the dollar, returning to a managed float based on a basket of currencies.
In Jan 2011, PBoC opens Yuan trading for U.S. customers.
In Feb 2011, U.S. Treasury says China’s exchange rate is “substantially undervalued” but declines to name China a currency manipulator.
About 7% of China’s foreign trade is settled in Yuan in the first quarter, most of it with Hong Kong. By the end of April, Yuan deposits in Hong Kong climb to 511 billion Yuan (USD 79 billion), or 8.4% of total deposits.
Starts trial for the Renminbi QFII program, allowing some fund-management and securities firms to invest their Yuan onshore.
China widens the Yuan’s trading band to 1 percent from 0.5 percent in the first such move since 2007.
China increases Qualified Foreign Institutional Investor (QFII) program quotas to USD 150 billion from USD 80 billion and expands Renminbi QFII beyond Hong Kong to include cities such as Singapore and London.
In March, China expands the Yuan’s trading band to 2% from 1%.
In June, Direct trading starts between the Yuan and the Pound.
In September, Direct trading between the Yuan and the Euro begins in China’s interbank foreign-exchange market.
In November, a trading link between the Hong Kong and Shanghai stock exchanges begins, allowing 23.5 billion Yuan (USD 3.7 billion) of daily cross-border transactions. Hong Kong also removes a Yuan conversion limit on its residents.
In Aug, The IMF says more work is needed before the Yuan can be granted Special Drawing Rights status and also propose that implementation of any changes to the basket be delayed until the end of September 2016.
On 11th Aug China slashes the Yuan’s fixing by a record 1.9%, sparking the biggest selloff since 1994.
In September, after a meeting between presidents Barack Obama and Xi Jinping, the two sides issue a statement saying the U.S. supports the inclusion of the Yuan, “provided the currency meets the IMF’s existing criteria in its SDR review.”
In November, IMF recommends the Yuan be added to the Special Drawing Rights, alongside the U.S. Dollar, Euro, Pound and Yen and on 30th November, IMF decides that the Yuan meets the standard of being “freely usable” and will join the USD, Euro, Pound and Yen in the Special Drawing Rights basket.
PBoc on 7th Jan, shocked the global market by setting the official midpoint rate on the Yuan, 0.5% weaker at CNY 6.5646 per USD, the lowest since March 2011.