MNI EXCLUSIVE: Yuan Fixing's Guiding Role Threatened By Spread

     BEIJING(MNI) - The widening spread between the People's Bank of China's

daily yuan rate and the currency's spot value is in danger of undermining the

guiding role of the central bank reference price, damaging its ability to

restrain further depreciation, although the authorities are likely to try to

keep the fixing stable for the near future, Chinese policy advisors told MNI.

     The deviation between the USDCNY highest spot price and the fixing was at

least 1.2% on each of the past four trading days, its longest period above 1%

since Aug. 11, 2015, when the PBOC shocked markets by lowering the reference

price by 1.87% against the dollar. While this deviation remains within the

PBOC's tolerance band of 2%, a government advisor told MNI that if it did not

narrow, the role of the fixing price as a market guide will weaken.

     "The central bank is trying to ease depreciation sentiment, while avoiding

having to spend forex reserves. But both verbal warnings and stronger fixings

will begin to struggle as tools for reducing volatility if market credibility is

lost," said the advisor, asking to remain anonymous.

     As of Thursday, the USDCNY fixing had risen by only 0.4% in the week, while

the onshore exchange yuan-to-dollar rate USDCNY added 1%. Both USDCNY and the

offshore USDCNH jumped to the highest levels since the 2008, as the yuan

weakened. The PBOC unexpectedly allowed the yuan fell through the 7 level on

Aug. 5, for the first time since the financial crisis, as the trade conflict

with the U.S. escalated.

     --CONTINUED PRESSURE

     The yuan is likely to face continued depreciation pressures, the advisor

said, with levels of 7.1 for the fixing and 7.2 for USDCNY the next to be

tested, unless the U.S. backs down on threats to impose additional tariffs on

$300 billion in Chinese imports. Yuan depreciation could also prompt retaliatory

devaluations from China's competitors, the advisor noted, expressing doubt that

talks with the U.S. would make progress even if negotiators meet in Washington

next month.

     A Hong Kong forex trader told MNI the central bank appeared to have made

greater efforts to shore up the yuan this week than in the period prior to its

having broken the previously key level of 7 to the dollar. At the same time,

market expectations of depreciation have risen.

     Guan Tao, former director of the international payments department at

China's State Administration of Foreign Exchange, told MNI the difference

between onshore and offshore prices blew out after the yuan breached 7.1 against

the greenback last week

     "But trading volume has not seen a big change and the market is basically

stable," he said, arguing that China has been making preparations for different

trade scenarios since August.

     --NO TRIGGER FOR OUTFLOWS

     For the moment, according to Chen Daofu, vice-director at the Financial

Research Institute at the State Council's Development Research Centre, there is

still no trigger for significant capital outflows, so long as the spread between

the offshore and onshore exchange rates remains under 200 pips and a

depreciation trend does not become too entrenched. He noted, though, that the

effects of U.S. tariff hikes on China only appear with a 6-9 month lag.

     "The negative impacts of a sharp depreciation need to be considered, since

it could intensify capital outflow and pressure repayment of foreign debts,

which may offset its effects on boosting exports," Che said. "A stable fixing

price helps stabilise market expectations."

     The central bank would continue to issue yuan-dominated bills to tighten

liquidity in the offshore market and support the currency if necessary, he

added.

     While a weaker currency can help support exports, any depreciation which

departs too far from fundamentals can be damaging, said Tan Yaling, head of the

China Forex Investment Research Institute.

     "The contribution of yuan depreciation to boosting exports is limited,

considering that exporters' profits have been constrained by falling orders. A

continuous depreciation could be a problem for exporters," she said.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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