Currency Dilemma Looms for PBOC in Post-Lunar Break Yuan Fixing

(Bloomberg) -- China’s central bank faces a difficult choice. Raising the yuan fixing on Monday to match last week’s dollar drop would undo much of the benefits of January’s depreciation. Any overt weakening bias after the week-long holiday risks worsening global market turmoil.

The monetary authority will probably choose the middle road and boost the daily reference rate slightly, according to Credit Suisse Group AG, which expects a fixing of around 6.52 to the dollar. That translates to a gain of 0.17 percent from Feb. 5, compared with a 0.9 percent retreat in a measure of the greenback. The offshore currency strengthened about 0.5 percent while China was on the Lunar New Year break.

“They have to take into consideration the big drop in the dollar while they were away,” said Nizam Idris, head of foreign- exchange and fixed-income strategy at Macquarie Bank Ltd. in Singapore. “But unfortunately for China, they’ve made it such that the market tends to read the fixing as a signaling tool, and that makes Monday’s reference rate very important.”

The People’s Bank of China has to tread a fine line between boosting the slowest economic growth in 25 years and avoiding a depreciation sharp enough to trigger capital outflows and a currency war. Foreign-exchange reserves fell $99.5 billion in January, the second-biggest drop on record, as the PBOC limited the yuan’s decline. Data scheduled to be released Monday will probably show exports contracted for the seventh straight month, making the case for a strong currency more difficult.

Outflow Risk

PBOC Governor Zhou Xiaochuan said there’s no basis for continued depreciation of the yuan because the balance of payments is good, capital outflows are normal and the exchange rate is basically stable against a basket of currencies, according to an interview published Saturday in Caixin magazine.

The onshore yuan has declined 1.2 percent this year, adding to the risk of further outflows. An estimated $1 trillion of funds left the country in 2015, more than seven times the amount of the previous year, as the yuan plunged 4.5 percent. This came as the PBOC devalued the currency on Aug. 11 in a move that rattled global markets and sent equities and commodities into a tailspin.

The monetary authority has stepped up efforts to stem the exodus, warning speculators that they will be punished. It intervened in the Hong Kong market last month after the yuan’s offshore exchange rate sank to a record discount to the onshore rate. Apart from selling dollars, the monetary authority also gave guidance to some Chinese lenders in the city to suspend yuan lending to curb short selling, a move that contributed to the overnight interbank lending rate surging to an all-time high of 66.8 percent on Jan. 12.

’Plan Unchanged’

“We do not expect the fix to be too strong over the course of the week as they don’t want a strong currency in general,” said Roy Teo, Singapore-based senior currency strategist at ABN Amro Bank NV, which Bloomberg data show had the most-accurate forecasts for the yuan last year. “Their plan, which has not changed and will not change, is basically to have a gradual depreciation of the currency against a trade-weighted basket. They will move along with the flow but there will not be too strong a yuan.”

Teo was referring to the CFETS RMB Index, which the PBOC unveiled in December while saying that the yuan’s performance shouldn’t be measured against the dollar alone. The basket is composed of 13 currencies, with weightings based mainly on international trade. The dollar has the largest share with 26.4 percent, followed by the euro and the yen with 21.4 percent and 14.7 percent, respectively.

Limited Room

Authorities can keep the exchange rate basically stable against the basket because the nation has ample currency reserves and a solid financial system, the China Foreign Exchange Trade System said earlier this month. The nation needs to keep the yuan steady to limit outflows, according to Goldman Sachs Group Inc. Policy makers are learning that they have very limited room to maneuver and that yuan weakness can be counterproductive, strategists led by Robin Brooks wrote in a note.

“I doubt they are going to rock the boat with a weaker fixing,” said Tommy Xie, a Singapore-based economist at Oversea- Chinese Banking Corp. “I expect a slightly stronger reference rate on Monday because of the weakness we saw in the dollar.”

--With assistance from Saijel Kishan and Molly Wei.

To contact the reporters on this story: Robin Ganguly in Hong Kong at rganguly1@bloomberg.net; Lilian Karunungan in Singapore at lkarunungan@bloomberg.net To contact the editors responsible for this story: James Regan at jregan19@bloomberg.net Robin Ganguly, Sandy Hendry