December 4, 2022

The renminbi’s sharp decline over the past week started after regulators told traders they were relaxing informal foreign exchange trading limits, according to people familiar with the matter.

The State Administration of Foreign Exchange often uses informal “window guidance” to manage the exchange rate, sometimes discouraging participation in the renminbi-dollar trade to slow the depreciation of the Chinese currency.

But two people familiar with the matter said SAFE officials announced an easing of informal limits on China’s interbank market transactions to foreign exchange brokers last Wednesday in the wake of the US Federal Reserve’s 0.75 percentage point rate hike. Reserve.

The move to ease trade restrictions on transactions was taken because policymakers “found the right time to let the renminbi depreciate a bit,” said one of the people.

SAFE did not immediately respond to a request for comment.

The easing of informal trading limits marks an inflection point for the tightly managed renminbi. The currency is subject to extensive capital controls and the dollar rate cannot fluctuate more than 2 percent in either direction of a daily trade band set by the People’s Bank of China.

Less than a week after SAFE’s move, however, top officials began making public statements countering the renminbi’s sharp declines. This turnaround reflected what traders and strategists said Beijing was focusing on avoiding a runaway depreciation that could threaten financial stability and fuel more capital outflows, as Chinese policymakers try to stimulate lagging economic growth.

In the most notable comments from a government official since the currency fell below Rmb7 against the dollar last week, Liu Guoqiang, vice governor of the People’s Bank of China, lashed out at traders betting on losses for the Chinese currency.

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“Don’t bet on a unilateral depreciation or appreciation of the exchange rate,” he warned at a meeting held by the industry body responsible for self-regulation of China’s foreign exchange markets. “The longer you bet, the more likely you are to lose.”

Line chart of renminbi per dollar showing the Chinese currency gaining a foothold in the face of dollar strength

The comments helped strengthen the renminbi, which rose 1.1 percent against the dollar after the PBoC also issued a statement late Thursday afternoon promising to “strengthen expectation management and maintain the base stability of the renminbi exchange rate at a reasonable and balanced level.” maintain the level”.

But currency traders, economists and market strategists said Liu’s warning was unlikely to turn the tide in favor of the renminbi, which has fallen nearly 11 percent against the dollar this year at about Rmb7.13 and is on track for an annual record drop.

Traders in Shanghai said the losses to the renminbi were mainly driven by a widening policy divergence between an aggressive Fed and a dovish PBoC working to amplify weak growth.

As a result, the long-standing interest rate advantage of China’s sovereign debt has been wiped out, removing a crucial driver of global investor influx. Data from Hong Kong’s Bond Connect program shows foreign outflows of nearly Rmb530 billion ($74 billion) from China’s renminbi bond market in the first eight months of 2022.

Another reason Beijing has taken a relaxed stance on the depreciation of the renminbi is that exchange rates have remained relatively stable against a broader basket of global competitors. The CFETS Renminbi Index, which measures the currency against China’s largest trading partners, is down less than 5 percent from its most recent peak in March.

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“I’d say the PBoC won’t have to sell a lot of foreign reserves this time around,” said Wei He, an analyst at Beijing consulting firm Gavekal Economics, pointing to the capacity of domestic financial institutions to intervene when called upon by the state. .

Column chart of yield advantage of Chinese government bonds with a maturity of 10 years against the US equivalent (percentage points) showing that the tables are spinning for investors in Chinese bonds

As Fed rate hikes drive up dollar debt yields, and as Chinese policymakers continue to support growth, analysts’ expectations are growing that the most likely reason for a halt to the renminbi’s fall could be a US recession.

“If the US goes into recession, the Fed could spin and start cutting interest rates – that would help the renminbi, as the interest rate spread [between the two countries’ bonds] would shrink,” said Steve Cochrane, chief economist for Asia-Pacific at Moody’s.

But he added that while this would help stabilize the renminbi exchange rate, “from an export standpoint, a US recession would weaken the Chinese economy” as foreign demand for goods from China dwindles.

Until the Fed stops raising rates, the PBoC is unlikely to burn the country’s foreign exchange reserves in an attempt to defend a specific level for the renminbi exchange rate, analysts say.

Instead, many expect China to continue to trickle down measures like those seen this week. On Monday, the PBoC introduced measures to discourage betting against the renminbi through the country’s derivatives markets. Such moves are typically introduced to China during periods of currency depreciation.

A Shanghai-based currency trader at a European bank said Monday’s move “could be viewed as a gesture rather than a real game changer for the direction of the market”.

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Another important factor in the trajectory of the renminbi is how China manages the expected easing of its strict zero-covid policy in the coming quarters. Some strategists expect a quick and comprehensive opening to allow outbound tourism would be negative for the renminbi, but others warn that this scenario is unlikely.

“If China’s opening is staggered as we expect, without any outbound tourism, it will be a risk and good for the domestic economy, driving the renminbi higher against the dollar,” said Danny Suwanapruti, head of Asia emerging markets. markets. currency and rate strategy at Goldman Sachs.

However, Suwanapruti added that due to the low liquidity in Hong Kong’s offshore renminbi market, traders would focus on other currencies in the region that often serve as a proxy for the renminbi’s exchange rate, following the Chinese lead. currency higher when it rises.

“The South Korean won is just cleaner than trying to play the dollar offshore renminbi,” he said.

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