PBOC could intervene if yuan falls

The People’s Bank of China wants the yuan to become a market-based currency, until it doesn’t.

Is anyone surprised?

china-yuanChina’s central bank has said it’s comfortable with the yuan, also known as the renminbi  (RMB), weakening against the US dollar, especially with the US Federal Reserve Bank expected to raise interest rates Wednesday for the first time since 2006.

But the central bank doesn’t want to see its currency experience a sharp depreciation, well, which central bank would? So, the PBOC is standing on alert, ready to intervene should there be a sudden attack on the yuan in the offshore markets, creating a destabilizing gap between the offshore and onshore exchange rates.

The bank opened the yuan up to the danger of an abrupt drop when it introduced the market-based mechanism to determine the daily opening rate, by devaluing the yuan by 2% in August.

If a sharp yuan depreciation happens, experts expect the PBOC to intervene, otherwise it would subject the already slowing economy to more financial risks and increase capital outflows.

Even though the dollar-yuan rate is at its lowest since July 2011, the PBOC wants the market to stop focusing on the yuan/dollar relationship. In an effort to do this, on Friday the bank launched a new index measuring the yuan against a basket of currencies.

“We should use the RMB index to show that the RMB has gained against most currencies, although it has depreciated against the dollar,” said a policy insider at the Commerce Ministry told Reuters. “We should find the yuan’s equilibrium exchange rate between the dollar, euro and yen,” he added.

However, the widening gap between the offshore and onshore rate is becoming a growing problem. Offshore, the yuan has already depreciated 2% this month, while onshore the currency is sheltered from market forces by China’s capital controls.

The situation gets stickier because in the wake of the International Monetary Fund accepting the yuan into its Special Drawing Rights (SDR) basket of reserve currencies last month, any new intervention by the PBOC could create diplomatic headaches.

“If the onshore-offshore spread is too wide, China will lose credibility after joining the SDR; it will have two currencies,” Zhou Hao, China economist at Commerzbank in Singapore told Reuters.

That would give ammunition to critics, especially in the US, who complain that China keeps its currency low to support otherwise uncompetitive exporters.



Categories: Asia Unhedged, China

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