August 11, 2016 4:20 pm JST

China marks time in march toward international yuan

YUSHO CHO, Nikkei staff writer

SHANGHAI -- In the year since China's surprise devaluation of its currency, the yuan's troubles going global have become all too apparent.

With the yuan continuing to lose strength as the Chinese economy slows, Chinese authorities have become reluctant to further expose the currency to market forces -- a step necessary to achieve true reserve currency status.

Last month, the People's Bank of China gathered local bank executives here for a meeting to inform them of de facto regulations on transactions that could facilitate capital flight. Officials from the central bank reiterated administrative guidance on a prior reporting requirement for large foreign-currency purchases or outbound fund transfers by corporations.

This guidance would not be put in writing, but banks were expected to comply, the officials said, according to people familiar with what transpired at the meeting. Banks were also instructed not to sell foreign currency to companies not registered in Shanghai.

In its 2016 report on internationalizing the yuan, released Wednesday, the PBOC hails rising cross-border transactions and the currency's progress toward global status. The Chinese leadership, under President Xi Jinping, has set a goal of having "a convertible, freely usable currency" by 2020.

But in a seeming contradiction to this aim, the central bank early this year introduced nationwide restrictions meant to block capital outflows, and has since tightened them. The yuan has been hit with bursts of activity that appear the work of short-sellers. Clearly afraid of letting the currency weaken or allowing capital outflows, the PBOC has put a halt to the liberalization on which the drive for a global yuan depends.

Yuan step too far

A year ago Thursday, without warning, the central bank moved to devalue the currency. The daily fix -- a reference rate around which the yuan trades, announced each morning -- had held at somewhat more than 6.1 yuan to the dollar for more than two years. But in just three sessions, it lurched to more than 6.4 yuan. This was the biggest loss of value for the currency since China shifted to a managed floating exchange rate in 2005.

Before last August's jolt, the yuan had been rising modestly with the dollar ahead of an expected U.S. interest rate hike. Chinese authorities apparently decided that it had gone too far. "There was a desire to support exports," says Zhao Qingming, chief economist of the China Financial Futures Exchange.

The PBOC later changed the obscure way it calculates the reference rate, adopting a method based on quotes submitted by 10 or more banks. This helped Beijing argue that the yuan deserved inclusion in the basket of currencies that determine the value of the Special Drawing Rights, the International Monetary Fund's reserve asset. The IMF eventually agreed.

But the side effects proved greater than the central bank had imagined. The yuan's slide and capital outflows continued unabated. Chinese companies, convinced the yuan would lose more value, rushed to pay foreign-currency debts ahead of time. Speculative bets against the yuan surged. The PBOC had little choice but to step in to defend the currency.

Longer march

Yuan-supporting interventions drained China's foreign exchange reserves, which had peaked at nearly $4 trillion, to $3.2 trillion. Between November 2015 and January 2016, the pace of decline reached $100 billion or so a month.

Further depletion threatened to undermine faith in China's sovereign credit. Thus constrained in its ability to intervene significantly in the currency market, the PBOC made the unpalatable choice of issuing administrative guidance that ran counter to the goal of a more international yuan. It did not help that an anticipated bottom in exports, thanks to a cheaper currency, proved elusive. Exports dropped 4% on the year in July.

"If [the central bank] tries to keep the yuan stable, curb capital outflows, and maintain foreign exchange reserves at the same time, liberalization will necessarily end up on the back burner," says Xiang Songzuo, an ex-PBOC official now teaching at China's Renmin University. Further moves to free up the yuan and other financial deregulation are unlikely in the short term, Xiang reckons.

The yuan is set to join the SDR basket in October. But milestones such as moving to a floating exchange rate and fully liberalizing foreign exchange -- which Japan reached in 1973 and 1998, respectively -- remain out of sight. This makes it hard for the yuan to build credibility as an international currency.

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