China to play it safe on yuan, fearing domino effect
Saturday, 6 December 2008
Kevin Yao
An abrupt drop in the Chinese yuan this week hurt battered Asian currencies and Beijing is expected to avoid sharp weakening out of concern that it may trigger a wave of competitive devaluations across the region.
China is Asia's dominant exporter and a sharp reversal of yuan's gradual climb would exert more pressure on several of the region's export-reliant nations that already grapple with a collapse in global demand for their goods.
If pushed against the wall, China's rivals could let their currencies weaken even further, undermining Beijing's efforts to help struggling exporters, some of which are shutting their doors as the global economy slides into a deep recession.
As a result, several analysts expect the authorities in China to attempt a fine balancing act -- nudging the yuan gradually lower over the months ahead, but not too rapidly in order to avoid a backlash from other Asian peers.
"It's likely that the Chinese authorities will start to push dollar/yuan slightly higher over the coming next months," said Thomas Harr, senior currency strategist at Standard Chartered Bank in Singapore.
"That will lead to the belief in the market that Asian currencies will weaken further," he said, predicting the yuan could weaken past 7 per dollar in the coming months.
While the yuan has been tightly managed by the central bank since its landmark revaluation in 2005, currencies of economies that have strong trade ties with China, such as the Taiwan dollar or the South Korean won , often take cue from yuan's movements.
For example, as the yuan fell, its daily correlation with the Taiwan dollar has strengthened.
The Singapore dollar and the Malaysian ringgit are also affected because their exchange rate regimes are similar to China's.
Analysts at ING changed their one-year forecast on the yuan to 7.22 per dollar from 7.03, which would represent a further 4.7 percent drop from current levels. One-year offshore forwards are pricing in a bigger drop to 7.275.
The yuan recovered a bit on Friday but has lost 0.7 percent this week, by far the biggest weekly drop since the revaluation. Gauges of implied volatility in the yuan options market have shot up.
The losses stirred speculation Beijing was changing tack to help exporters after it let the yuan to strengthen 18 percent since its revaluation in 2005 and kept it steady in the past five months even as other Asian currencies fell due to the darkening global outlook.
"Driving this new policy would seem to be the desire to put all the stops to prevent GDP growth falling below 8 percent in 2009 -- especially since exports are still around a third of GDP," said analysts at ING in a note to clients.
China's economic growth slowed to 9 percent in the third quarter after years of double-digit expansion and a threat of a deeper slowdown made the authorities adopt a nearly $600 million stimulus package and slash interest aggressively last month.
But some analysts are sceptical whether a change in yuan policy was in fact part of its economic rescue plan.
"The massive slowdown in China's exports cannot be reversed by yuan depreciation, not to mention that there would be a new round of competitive depreciation if China chooses to do so," said Frank Gong, chief China economist at JPMorgan, brushing away suggestions China had quietly changed currency policy.
It could also stoke the ire of the United States and other countries that may see any yuan weakness as a protectionist move on trade. U.S. manufacturers called the yuan drop this week "extremely disturbing."
A decade ago, China won wide praise for resisting a yuan devaluation during the Asian financial crisis when it was feared that such a move would make worse the sell-off in regional currencies.
This time, competitive devaluations are seen as a more remote threat, given that they could hurt already fragile investor confidence in the region. The broad MSCI index of Asia-Pacific shares outside Japan has plunged almost 60 percent this year.
Still with Beijing expected to allow some yuan weakening, other governments may also be more prepared than before to tolerate some weakness in their currencies.
"If market pressures persist, central banks may be more tolerant of permitting further currency weakness," said Stephen Jen, head of currency research at Morgan Stanley.
— Reuters
An abrupt drop in the Chinese yuan this week hurt battered Asian currencies and Beijing is expected to avoid sharp weakening out of concern that it may trigger a wave of competitive devaluations across the region.
China is Asia's dominant exporter and a sharp reversal of yuan's gradual climb would exert more pressure on several of the region's export-reliant nations that already grapple with a collapse in global demand for their goods.
If pushed against the wall, China's rivals could let their currencies weaken even further, undermining Beijing's efforts to help struggling exporters, some of which are shutting their doors as the global economy slides into a deep recession.
As a result, several analysts expect the authorities in China to attempt a fine balancing act -- nudging the yuan gradually lower over the months ahead, but not too rapidly in order to avoid a backlash from other Asian peers.
"It's likely that the Chinese authorities will start to push dollar/yuan slightly higher over the coming next months," said Thomas Harr, senior currency strategist at Standard Chartered Bank in Singapore.
"That will lead to the belief in the market that Asian currencies will weaken further," he said, predicting the yuan could weaken past 7 per dollar in the coming months.
While the yuan has been tightly managed by the central bank since its landmark revaluation in 2005, currencies of economies that have strong trade ties with China, such as the Taiwan dollar or the South Korean won , often take cue from yuan's movements.
For example, as the yuan fell, its daily correlation with the Taiwan dollar has strengthened.
The Singapore dollar and the Malaysian ringgit are also affected because their exchange rate regimes are similar to China's.
Analysts at ING changed their one-year forecast on the yuan to 7.22 per dollar from 7.03, which would represent a further 4.7 percent drop from current levels. One-year offshore forwards are pricing in a bigger drop to 7.275.
The yuan recovered a bit on Friday but has lost 0.7 percent this week, by far the biggest weekly drop since the revaluation. Gauges of implied volatility in the yuan options market have shot up.
The losses stirred speculation Beijing was changing tack to help exporters after it let the yuan to strengthen 18 percent since its revaluation in 2005 and kept it steady in the past five months even as other Asian currencies fell due to the darkening global outlook.
"Driving this new policy would seem to be the desire to put all the stops to prevent GDP growth falling below 8 percent in 2009 -- especially since exports are still around a third of GDP," said analysts at ING in a note to clients.
China's economic growth slowed to 9 percent in the third quarter after years of double-digit expansion and a threat of a deeper slowdown made the authorities adopt a nearly $600 million stimulus package and slash interest aggressively last month.
But some analysts are sceptical whether a change in yuan policy was in fact part of its economic rescue plan.
"The massive slowdown in China's exports cannot be reversed by yuan depreciation, not to mention that there would be a new round of competitive depreciation if China chooses to do so," said Frank Gong, chief China economist at JPMorgan, brushing away suggestions China had quietly changed currency policy.
It could also stoke the ire of the United States and other countries that may see any yuan weakness as a protectionist move on trade. U.S. manufacturers called the yuan drop this week "extremely disturbing."
A decade ago, China won wide praise for resisting a yuan devaluation during the Asian financial crisis when it was feared that such a move would make worse the sell-off in regional currencies.
This time, competitive devaluations are seen as a more remote threat, given that they could hurt already fragile investor confidence in the region. The broad MSCI index of Asia-Pacific shares outside Japan has plunged almost 60 percent this year.
Still with Beijing expected to allow some yuan weakening, other governments may also be more prepared than before to tolerate some weakness in their currencies.
"If market pressures persist, central banks may be more tolerant of permitting further currency weakness," said Stephen Jen, head of currency research at Morgan Stanley.
— Reuters