MNI INTERVIEW: PBOC Would Curb One-Way Bets On Yuan-Guan Tao

The People's Bank of China would take measures to curb any one-way market bets on the yuan, but it seems likely that the current strength of the currency will moderate in the new year as export growth slows and the Fed tightens monetary policy, a former senior official at the country's foreign exchange administration told MNI.

Regulators should also further loosen controls on overseas portfolio investment by Chinese financial institutions, to offset the surging trade surplus which has helped push the yuan up over 10% since May 2020, Guan Tao, a former Director General of Balance of Payments at the State Administration of Foreign Exchange, said in an interview. Domestic demand for yuan could strengthen towards the end of the year, he said.

While China's forex policy focuses on managing market expectations rather than targeting a central level against the dollar, the central bank will closely watch sentiment for signs of overshooting, Guan said.

Last week, the China Foreign Exchange Committee, guided by the central bank, asked companies and financial institutions to limit themselves to risk-neutral positions when trading foreign exchange, in a move widely interpreted as meant to discourage further yuan appreciation.

Guan, now global chief economist at BOC International, said the "risk neutral" guidance was necessary following growth in betting on the yuan in FX markets in recent years, and that companies need to hedge possible depreciation risk even when the currency is rallying.

RALLY MAY BE ENDING

The yuan's rally against the greenback has continued despite broad dollar strength this year. It has gained 2.1% against the U.S. currency, with roughly half that advance coming since October, when it broke the key 6.40 level. The Chinese currency has soared 10.2% against the euro and 12.2% against the yen in the same period, taking the CFETS RMB index to a six-year high.

An unexpectedly large trade surplus and capital inflows generated by relatively high Chinese bond yields have driven the yuan higher, Guan said. The trade surplus has expanded by 63% year-on-year over the past two months, while capital inflows powered an annual 40% higher from January to October, as bond and equity connect schemes opened new channels to foreign investors. Banks reported selling a net USD194.4 billion of yuan from January to October, up 101% y/y.

But export growth may moderate in 2022 as global supply chains return to normal following the pandemic, while Fed tightening should narrow yield spreads between U.S. and Chinese bonds, potentially fuelling bets on yuan depreciation, said Guan, adding that there was a danger that the currency's rapid rally could set up a similarly speedy decline. Weakening exports could encourage investors to sell the yuan, he said, particularly given the rise in the CFETS RMB index. A similar view is shared by policy advisors in Beijing, as MNI has reported. (See MNI: Yuan Seen Trading Near 6.40 Before Q1 Weakness-Advisors)

While the PBOC has historically been more tolerant of yuan strength than weakness, it could move against any significant depreciation if necessary, by means such as reintroducing the counter-cyclical factor into its daily CNY fixing, he said. But the significant improvement in private sector currency mismatch should make Chinese companies less exposed to movements in the yuan, potentially allowing the authorities to be more tolerant of exchange rate variations, which help to absorb external and internal shocks, he said.