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Forex

Yuan outlook stays dim despite Beijing pushback

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Investors watch the Shanghai stock market Friday.   © Reuters

SHANGHAI -- China's central bank gave the yuan a lift Friday despite widely held expectations of a continued slide, putting investors on alert with an apparent shift away from market-based policy.

     The People's Bank of China raised eyebrows by setting its guidance rate for the yuan at 6.5636 to the dollar, around 0.5% stronger than Thursday's market close and the first increase in nine days. The Shanghai Composite Index rebounded nearly 2% Friday on speculation that the currency's steep tumble could be coming under control.

Taking a step back

To keep a handle on its currency market, China allows the yuan to be traded only within a 2% band above and below the reference value set each morning. That rate had long been seen as a mechanism by which the central bank would control the currency against market pressure.

     That seemed to change in August, when the bank cut its reference rate 2% and resolved to begin setting the value close to the previous day's Shanghai market close, bringing policy more in line with market forces. But Friday's rate, a good distance away from the yuan's market value, raised suspicions that Beijing could be reverting to its old ways.

     Also Friday, China's securities regulator abolished the so-called circuit-breaker mechanism put in place Monday to halt stock trading during particularly turbulent periods. Far from making the market more stable, sudden trading halts invited chaos as panicked investors sold off assets. Markets are increasingly leery of Beijing's inconsistent policy efforts.

Rise and fall

Beginning in the 1990s, Beijing was known to keep the yuan at artificially low levels through strict market controls to support China's export-driven growth push. The central bank even enforced a de facto peg during particularly rough times, such as after the 1997 Asian currency crisis or in the wake of 2008's global financial collapse.

     China began letting the yuan strengthen in June 2010, having gotten back on its feet after the worst of the economic crash. The currency surged around 10% between then and its peak in January 2014, helped by President Xi Jinping's support for a strong yuan after taking office in November 2012.

     Yet by August 2015, the yuan had climbed too high, becoming a burden on the Chinese economy. By bringing the currency in line with market demand, the central bank allowed it to drop by around 2%, and then let it weaken more in the following months.

     Many think the yuan is still overpriced. In Hong Kong, London and other offshore markets not bound by People's Bank regulations, speculators are boosting sales of the currency, thereby putting downward pressure on the Shanghai market as well. Many are growing worried that the yuan's latest dive could hamper China's slowing economy further by exacerbating capital flight.

     The yuan will land between 7 and 7.5 to the dollar by the end of 2016, Zhou Yu of the Shanghai Academy of Social Sciences predicts. Market interventions to prop up the yuan will drain foreign currency reserves, generating further downward pressure, he said.

     A sizable surplus in production capacity, slowing population growth and an aging population are eating away at China's potential growth rate. The yuan's appropriate exchange rate, based on the strength of the economy, is thus seen sliding as well. "The currency could end up falling even farther than it has climbed," Credit Agricole's Yuji Saito said.

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