Beijing’s attack on yuan speculators risks backfiring

Reuters/Beijing

China’s central bank rattled speculators this week by engineering a sudden fall in the yuan against the dollar, but economists warn that induced downside risk was no substitute for true liberalisation in the currency market.

Unless the central bank takes bolder steps toward allowing the market to determine the exchange rate, traders believe the correction could do little more than present speculators with a fresh buying opportunity.

Beijing has committed to letting the market determine the yuan’s true value, part of a wider project to encourage international usage of the currency to rival the dollar.

The yuan’s orchestrated reversal also has unleashed speculation that the central bank is preparing to widen the currency’s daily trading band, currently set at 1% either side of a daily midpoint fixed by central bank.

But even if the band is widened, traders doubt whether it can hold the yuan back from strengthening further, given the enduring ability of Chinese assets to attract capital inflows.

Since January 13, the spot yuan has undergone an unprecedented fall of more than 1.5%, guided downward by the central bank with the help of major state-owned banks, which traders say were selling off yuan at the central bank’s behest.

Wang Jun, senior economist at the China Centre for International Economic Exchanges (CCIEE), a well-connected think tank in Beijing, told Reuters that the central bank had to deliver a clear message to speculators.

“It needs to tell the market, ‘No more one-way rise for the yuan,’ and introduce two-way fluctuations in the rate like other major currencies have,” Wang said. The country’s foreign exchange regulator attempted to soothe markets yesterday afternoon, saying that the adjustment was “normal,” resulting from market players independently unwinding their long yuan positions. But most participants believe this unwinding was defensive, triggered by state-owned banks’ massive dollar purchases.

As a relatively low-risk, high-yield currency that has gained over 35% against the dollar since it was revaluated in 2005, the yuan remains a favourite among international investors.

The Greek debt crisis in early 2012 did provoke a brief swoon that saw the currency lose 1.6% in six months, but it began to recover in July 2012 to gain as much as 5.5% by mid-January.

In reaction to this inexorable rally, speculators onshore and off built huge long yuan positions on assumption that the bull party would run and run.

Speculative foreign capital inflows appeared to gather pace from the fourth quarter through January, data from the State Administration for Foreign Exchange suggested. Most economists expect the trend to continue this year, unless the yuan enters an extended decline.

The China central bank has attempted to deter yuan bulls in the past, but seldom achieved much success.

Most economists and traders still expect the yuan to appreciate between 2-3% this year, even given recent developments.