Yo-yo yuan: up today, down tomorrow

For two days running, Chinese authorities have pulled out the big guns — and some big talk — to target currency speculators who have been betting against the Chinese yuan. And from all accounts, the authorities have won this round, effectively propping up the yuan after its steep declines last week.

But it’s far from clear that the last shots have been fired in this face-off.

On Tuesday, short-term yuan-denominated borrowing costs in Hong Kong surged nearly five-fold overnight, evidently after intervention by China’s central bank, the People’s Bank of China, to dry up offshore yuan liquidity that short-sellers were channelling to drag down the onshore currency value. Chinese policymakers also uncharacteristically came out publicly to talk up the yuan.

These interventions had the effect of shoring up the yuan: its onshore and offshore values traded almost on a par on Tuesday, bridging the 2 per cent gap last week that had signalled a further yuan devaluation.

All this should have calmed global investor sentiments, which have been battered in recent days by the currency and stock market turmoil with its epicentre in China. But there was little evidence of that on Tuesday: for instance, the Sensex and Nifty closed down, even though they recouped much of the steeper losses from earlier in the day.

That’s because global investors’ faith in the infallibility of Chinese policymakers stands on slippery ground today. For all the armoury at their disposal, including foreign exchange reserves of an estimated $3.3 trillion, Chinese authorities, who could once do no wrong in the estimation of the markets, no longer seem capable of exercising the same immaculate control over the economy.

Some of this is, of course, par for the course for an economy that has hurtled along at a supernormal pace for so long and is making the transition from a command-and-control financial system to one that is seeking greater integration with the global grid. After all, the endeavour to get the yuan included in the IMF’s basket of reserve currencies was underwritten by considerations of national prestige. And it came inbuilt with the inevitability of a loss of control over the levers and a concession to the uncertainties of the marketplace.

But more disquietingly, Chinese policy directives, which once had the firepower of a bazooka, are today about as effective as blanks. And, as has been evident more recently, Chinese authorities too are prone to policy missteps.

It is this that reinforces currency speculators’ faith that, while their heads may have been bloodied by Tuesday’s intervention to prop up the yuan, they remain unbowed. The yuan today has rather more downside risk riding on it than any upside potential.

UBS China Economist Tao Wang notes that against a backdrop of US rate hikes and a strengthening dollar, the PBoC will attempt to decouple the yuan from the dollar and allow for a moderate (5 per cent) depreciation with increased two-way volatility. But conversely, she adds, “There is also a risk that the yuan depreciates by more than 10 per cent this year, either because of overwhelming depreciation expectations or persistently large capital outflows, or a much bigger strengthening of the US dollar, or China’s growth falling off a cliff.”

Clearly, despite the market action today to prop up the yuan and tame speculative short-sellers, the last word hasn’t been said on this subject. The tug-of-war over the yuan’s value will continue awhile.

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