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China Changes Its Currency-Market Ways
Beijing’s typically ham-handed approach to yuan interventions may be giving way to subtler techniques
By ANJANI TRIVEDI
Nov. 12, 2015 2:24 a.m. ET
China’s typically ham-handed approach to currency interventions—exemplified by its market-wrenching August devaluation—may be giving way to a lighter touch.
In recent weeks, traders say, Beijing has been getting its message out more subtly, buying and selling in the freely traded offshore yuan and forwards markets. They praise the change, saying it boosts their confidence in China’s efforts to guide the value of its currency and calm markets.
“We understand more about their reaction function and thought process,” said Beng-Hong Lee, head of markets for China at Deutsche Bank.
The change, though, also highlights the shortcomings of a largely closed-off capital account that leads to different values for yuan trading inside and outside the country. And it risks turning those offshore markets, now freely traded, into ones heavily influenced by China.
Beijing’s shift is largely the product of its pursuit of reserve-currency status for the yuan, alongside the U.S. dollar, yen, sterling and euro. Even as the country’s wider financial overhaul has slowed in recent months, Beijing has rapidly ticked off the goals set for the yuan by the International Monetary Fund, which is expected to make a decision on including the yuan in its reserve-currency basket in the coming weeks. One hurdle—that countries be able to freely buy and sell the yuan—could prove difficult even with this new style of intervention.
The shift does put the People’s Bank of China more in line with other emerging-market central banks, which routinely intervene to damp volatility or control the value of their currencies. The PBOC is still trying to win back credibility lost when its summer devaluation caught investors off guard and sent a ripple of anxiety through global markets. Within days the central bank was in full volatility-quelling mode, holding a rare news conference and injecting billions of dollars.
“Market confidence is very critical to the currency,” said Charles Feng, head of foreign-exchange trading at Standard Chartered in Hong Kong, especially as China gradually opens its capital account. China has largely defused market fears of rapid depreciation, he said: “Recent action reflects that priority.”
Beyond the symbolism, Beijing has good reason to want reserve-currency status. Standard Chartered estimates global central banks will buy $85 billion to $125 billion worth of yuan next year if the currency is included in the IMF’s basket, $56 billion if it is not.
Until last month, China had suffered several months of falling reserves, though it still has a war chest of $3.5 trillion. That could be one reason the PBOC started to use the forwards market, analysts say. Its buying of yuan there doesn’t show up in foreign-exchange reserves immediately, unlike buying in the spot market.
One of the biggest challenges for Beijing is the yuan’s two exchange rates. In recent months, the central bank has worked to bring the two within a consistent, narrower range.
For years, the PBOC’s heavy-handed interventions succeeded in quickly moving the market where Beijing wanted it to be, but the lack of warning or guidance—which contrasted with the practices of other central banks —frustrated investors. The interventions were often followed by a tug of war between the central bank and the market, with the PBOC ultimately quashing pressure by selling U.S. dollars through the large state banks, as in the days after the devaluation.
Inside China, the central bank sets a daily reference rate and allows the yuan to trade 2% above or below this rate. Recently the bank has been setting this rate in line with where the yuan closed the previous day, where in the past it was often far afield. This sign the PBOC is taking market signals into account has reduced investor uncertainty and allowed the onshore and offshore yuan rates to converge.
The real test of the PBOC’s shift will come if Beijing decides the yuan needs further weakening to boost the economy. The central bank will lose whatever investor confidence it has gained if it handles the devaluation the same way it did in August.
The PBOC didn't respond to a request for comment, and it hasn't said whether it is intervening in the offshore or forwards markets. But there are signs: In September, banks’ foreign exchange sales and the central bank’s net foreign assets diverged, suggesting the PBOC, rather than using its own cash to buy yuan, is intervening by other means.
The shift in tactics has emerged in the past two months. In September, traders spotted China’s central bank intervening for the first time in the offshore yuan market. The yuan offshore strengthened by as much as 1.35% that day.
In late October, the price of yuan one-year forwards contracts dipped sharply; since then it has been broadly flat. Investors believe the central bank is active in this market, steering investors’ outlook—effectively telling the market that yuan won't depreciate as much as they were expecting over the next year.
The offshore spot and derivatives markets have grown rapidly in recent years. The rate of the freely traded offshore yuan at times has led onshore trading sentiment, veering beyond the daily limits on the mainland. As the PBOC has intervened in trading offshore, the market has hewed closer to the official rate, which has made it less useful as a gauge of investor sentiment.
Write to Anjani Trivedi at anjani.trivedi@wsj.com
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