MNI: A Sharply Weaker Yuan Looms As A Threat To China's Trade

China’s closely linked import and export industries confront higher raw material costs as the yuan continues to fall despite efforts by the central bank to slow its slide, highlighting the need for exporters to prepare for more two-way volatility, policy advisers and analysts told MNI.

The weakness in the yuan against the U.S. dollar - it fell to a near 15-year low of 7.32 on Nov 1 - risks reverberating through Chinese industry by raising the cost of imports like commodities, which then would have a knock-on effect on exporters who require these raw materials, or components made from these products, in their own production processes.

A weaker yuan would typically support China’s exports but it’s unclear how much of a boost it will provide as external orders have started to soften as global growth slows, said Tan Yaling, head of the China Forex Investment Research Institute.

Tan, a former Bank of China official, is concerned the “extremely wide band” the yuan has traded in this year – between CNY6.3 and CNY7.3 against the dollar - will challenge not only traders’ forex management and but also commercial forex strategies. She urged exporters to implement hedging to protect against a strengthening of the yuan.

The weak yuan is a problem for Beijing as it not only affects exporters, but also undermines its attempts to raise the global status of the yuan. A priority for the PBOC would be to prevent a “resonance effect”, said Lian Ping, head of the Zhixin Investment Research Institute, highlighting the relationship between a weaker yuan, capital outflows and market expectations about the direction of the currency. (See MNI Interview: PBOC FX Intervention Still An Option – Guan Tao)

MORE VOLATILITY AHEAD

The renewed weakness in the yuan has been stoked by concerns about China’s new leadership team and the nation’s Covid-Zero strategy. (See MNI POLICY: China’s New Leaders Face Challenges in Reform Push)

More volatility is expected against the dollar over the rest of the year, a currency trader told MNI.

“There was a sign of a one-way bet shorting the yuan this month since the dollar index went down but the yuan continued to drop. In addition, the yuan is getting weaker against the currency basket,” the trader said.

The yuan’s weakness against the basket and increasing one-way bets on the currency prompted the PBOC to ease controls on capital inflows in late October by raising its macro-prudential adjustment parameter for cross-border financing of companies and financial institutions, he said. (See MNI BRIEF: PBOC Eases Capital Inflow Controls As Yuan Slides)

“Since the drop in the yuan has overshot, it is possible that the currency would rebound at a larger and faster pace if the dollar softens,” the trader said.

The PBOC needs to monitor and act to curb excess movement to safeguard the yuan at a certain level, as well as its band, said Guotai Junan International chief economist Zhou Hao, adding he viewed 7.23 to 7.25 as a key level for the yuan.

The PBOC pledged to “enhance the flexibility of the yuan exchange rate” and maintain the stability of the yuan at a "reasonable and balanced level” in a recent statement.

The PBOC has many tools to manage the currency, including changes to its forex reserve requirement ratio, risk RRR for forex trades in the forwards market, and managing liquidity in Hong Kong through PBOC bills. Changes to cross-border financing capital controls are also an option, analysts said.