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Analysis-How China talked markets out of a run on the yuan

Analysis-How China talked markets out of a run on the yuan


SINGAPORE (Reuters) – China has sought to stabilize the yuan in recent months by orchestrating purchases by state banks and giving market advice to bankers.

The moral suasion strategy marks a radical departure from the approach Beijing took the last time the currency was on the ropes, in 2015.

At the time, the People’s Bank of China (PBOC) resorted to official intervention by burning $1 trillion in reserves to shore up its reserves.

This year, as China’s economy faltered and money left the country, the PBOC took a radically different approach, defending the currency by signaling to markets what kind of selling it would and would not tolerate.

Interviews with 28 market participants show at least two dozen instances where regulators closely and frequently directed market participants through a series of coordinated actions this year to resist strong downward pressure on the yuan.

The People’s Bank of China and the State Administration of Foreign Exchange, the foreign exchange regulator, did not respond to questions faxed by Reuters about its approach. People’s Bank of China Governor Pan Gongsheng previously said regulators would prevent risks of the exchange rate overshooting and maintain stable operations in the foreign exchange market.

The strategy described by market participants and analysts to Reuters helped avoid a destabilizing fall in the yuan.

However, they told Reuters it had also crippled much of China’s foreign exchange market, sending trading volumes tumbling and raising questions about the yuan’s chances of becoming a global reserve currency.

“The circumstances … are currently considerably more complicated because there are both domestic and global macroeconomic factors,” said Eswar Prasad, Tolani Senior Professor of International Trade Policy at Cornell University.

He described the People’s Bank of China’s use of “unconventional measures to intervene in foreign exchange markets” as a form of “triage” to prevent the yuan from falling too quickly.

As the currency of the world’s second-largest economy and top exporter, the value of the yuan determines the price of goods around the world and trillions of dollars of capital flows. It also serves as a barometer of China’s challenges.

A Chinese foreign exchange regulator, speaking on condition of anonymity, said the currency’s value was ultimately determined by fundamentals and was currently a product of “how effectively China can counter decoupling “, a reference to Western efforts to reduce economic dependence on China.

Ten traders interviewed by Reuters said the main warnings first emerged in June when the PBOC’s daily forecasts on the yuan that determine its trading range for the day, known as the midpoint, began to change. deviate from market expectations.

In theory, the midpoint is based on contributions from 14 banks and refers to the previous day’s trading and day-to-day movements, which should make forecasting easier for markets.

However, in August, the midpoint’s yawning gap from traders’ estimates was interpreted by traders polled by Reuters as a signal that the PBOC did not want the currency to go where markets pushed it.

AGAINST THE TIDE

Managing a currency can be a real headache. In 2015, China reduced the midpoint price of the yuan by 2%, with the People’s Bank of China saying it was a one-time measure to bring the trading margin in line with market prices. However, fearing further devaluations, investors sold Chinese assets, causing stocks and the yuan to plummet and forcing the bank to use its reserves to stabilize the currency. This time, efforts to manage the yuan have involved more targeted and specific instructions to banks and foreign exchange market participants, according to traders who spoke to Reuters.

For example, whenever dynamics looked unfavorable for the yuan, state-owned banks quietly became buyers, traders said. This usually occurred around psychologically significant currency levels and appeared to be aimed at containing volatility. These traders told Reuters they noticed in late May that state banks intervened by buying yuan for two days after the currency hit its 2023 low.

Similarly, purchases of yuan by state banks intensified in December after Moody’s announced a downgrade in China’s rating outlook. Individual traders were unable to estimate the scale of the buying and Reuters was also unable to confirm whether the trading was directed by the central bank.

Official data shows no evidence that the People’s Bank of China sold dollars as it did in 2015. However, market participants noted that banks sold dollars acquired through currency swaps, which which would not be visible in such data.

At the same time, smaller lenders have faced an increase in “window guidance” or unofficial verbal advice from regulators for banks and their customers to reduce their dollar holdings, according to six trade sources and banking.

In June and July, China’s foreign exchange market self-regulatory framework, overseen by the People’s Bank of China, required major state-owned banks to reduce dollar deposit rates, which would encourage exporters and households to convert their dollar revenues in yuan, market watchers said.

WORKING THE PHONES The pressure on bankers mirrored pressure on the yuan, which is down nearly 2.8% against the dollar this year, even as the benchmark dollar index lost 2.2%.

On September 8, the yuan reached its lowest level in 16 years. A few days later, the heads of eight major banks were summoned to Beijing to meet with PBOC officials, according to five banking sources, two of whom were present at the meeting. They were told that companies wanting to buy for more than $50 million would need PBOC approval, three sources said. Bankers were also asked to reduce spot trading, stagger dollar purchases and not hold net long dollar positions at the end of a trading day, two sources said.

Authorities have also focused on monitoring exporters’ foreign exchange buying and selling plans, given their large foreign currency holdings and outsized influence over the yuan’s movements.

In recent months, regulators have been calling banks and probing them with near-weekly surveys about the intentions of exporting customers, according to officials at five banks interviewed by Reuters. Such calls were previously sporadic and surveys were only sent monthly.

Overseas yuan trading volume fell 73% from August’s level to a record high of 1.85 trillion yuan in October. This shows that Chinese bankers have responded to the call to reduce trade, particularly dollar purchases, but also that the central bank’s efforts are cooling the market, analysts say. For now, however, the currency appears to have stabilized comfortably above September’s 16-year low.

Market participants are not willing to fight the PBOC directly, but they are also not willing to fully consent to it.

“I have been watching dollar prices closely this year because I receive dollar payments every few weeks,” said Zhu, a Shanghai-based exporter of electronic components. “The daily question has been, ‘Should I keep them or convert them back to yuan?'” So far, she has saved them in the hope of a better yuan price for her dollars.

(Reporting by Reuters staff. Writing by Tom Westbrook. Editing by Paritosh Bansal and Sam Holmes)



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