Chinese regulators will carefully control the CNY’s fall to avoid market instability at a politically sensitive time
China’s central bank (PBoC) will pursue a “managed depreciation” strategy in the coming months, as investors cut their exposure to yuan-denominated assets in search of assets with higher returns elsewhere. Businesses should prepare for the Chinese yuan to continue weakening over the rest of the year, and likely into Q1 next year, although its pace will be carefully controlled. Firms should also plan to deal with an even tighter FOREX regulatory environment, where more rules to control capital outflows could be put in place. In this regard, expect more red tape and administrative hassles in terms of day-to-day treasury and capital management, especially those involving cross-border transactions.
- China’s CNY depreciated rapidly over the past week, with the USD/CNY rate falling to its lowest level since 2008.
- The onshore CNY has fallen more than 13% against the US dollar this year.
- In response, the PBoC intervened, hiking the risk reserve ratio for FOREX forward to 20% for financial institutions, up from the previous level of 0%.
- Earlier this month, the PBoC also cut the amount of FOREX reserves that financial institutions must hold, cutting the FOREX reserve requirement ratio to 6%, down from 8%.
The Chinese yuan fell so much and so quickly in recent days in response to an aggressive rate hike by the US Federal Reserve. The CNY is not the only currency in the APAC region under substantial depreciatory pressure as a result of the Fed’s actions, but the PBoC is the only major central bank in the region that’s moving in the opposite direction in terms of interest rates. The PBoC faces an unenviable task of striking a delicate balance between supporting economic growth (where, ideally, it can cut rates as much as necessary) and preventing excessive capital outflows (where it doesn’t want to cut rates too much) that could destabilize domestic financial markets. By now it’s obvious that the so-called psychological line of “7” does not exist anymore. As the CNY continues to fall, the risk of capital outflows will increase, leading to more potential for instability in China’s domestic markets. Considering that this is one of the most sensitive times for China’s leadership in years (due to the upcoming leadership transition), it’s clear that the PBoC will not sit idly by and watch the CNY fall freely. Instead, it will continue to adopt a strategy of “gradual depreciation” in an effort to maintain market stability.
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