The Chinese yuan is currently trading just below the psychologically important level of 7 against the U.S. dollar. It peaked at 6.92 per dollar in May and has been largely kept below that level by the efforts of the People’s Bank of China (PBOC).
Falling yuan
The PBOC has been using its usual methods to keep the yuan in check, including limiting liquidity in overseas markets. The central bank had indicated that it would be selling off bills in Hong Kong, which would drain offshore liquidity and help stabilize the currency’s exchange rate.
“The PBOC hopes to stabilize the fixing at 6.9, which helps anchor market sentiment and ensures the spot rate doesn’t weaken too much… China won’t likely set the rate weaker than that level tomorrow either because then Asian markets would feel nervous and sell the yuan and other currencies,” Gao Qi, a currency strategist at Scotiabank in Singapore, said to Bloomberg.
The all-important level of 7 was breached last time during the 2008 financial crisis. For about 11 years since then, the yuan has been kept below 7 to the U.S. dollar. So why is the currency trying to breach the level? The answer lies in the U.S.-China trade war. The conflict has created so much uncertainty in the markets that investors are selling off their yuan.
A lower yuan is something that will be advantageous to China as it will help to counter the effect of increased tariffs. Plus, Beijing also does not have to impose tariffs on U.S. imports as retaliation. However, a depreciated yuan would make trade negotiations with the U.S. much more difficult as it would send a signal to Washington that China is not honest in its intention to resolve the trade dispute.
The depreciation pressures on the yuan are only expected to get stronger in the coming months as Chinese companies that are listed offshore start selling the currency to fund their dividend bill. The process is expected to last until August. Companies are expected to sell US$18.8 billion worth of yuan during this period compared to US$19.6 billion last time. The yuan has dipped around 3 percent this month, making it one of the worst-performing currencies in the world.
Bad for China?
In addition to antagonizing America, a declining yuan is bad for China for another reason — it will trigger investors and companies to start transferring money out of the country.
“This would cause a wave of turbulence in Chinese stocks and assets (which it historically has). Especially as Chinese citizens begin trying to move their assets out of the Mainland. And foreign investors dump Chinese stocks so that they can pull their capital out — causing markets to plunge. This is the last situation Chinese leaders want to be in… China’s already slowing economy can’t handle this outcome — and neither can their fragile banking and corporate sector,” according to Speculators Anonymous.
Such an event will force Beijing to tap into its US$3 trillion reserves to defend the currency’s slide. Recently, President Xi pledged to act against currency depreciation. A devalued yuan can force foreign investors to sell off Chinese assets and curtail capital inflows into the country. Consumers will be less willing to spend their money with a weaker currency and businesses will lose their motivation to make investments. Next month, President Xi is expected to meet with President Trump at the “Group of 20” meeting in Japan. Positive news from the meeting can help stabilize the yuan against the dollar.
