China: PBoC engineers a depreciation path for the Yuan – BNZ

Jason Wong, Currency Strategist at BNZ, suggests that part of the PBoC’s strategy over the past year has been to only allow a gradual decline in China’s exchange rate, keeping it higher than otherwise.

Key Quotes

“There has been significant downward pressure on the Yuan as China faces net capital outflows.

To maintain some sort of control over its exchange rate the PBoC changed its CNY/USD exchange rate fixing methodology in August 2015. The persistent weakness of the CNH/USD exchange rate (the freely traded offshore equivalent exchange rate) relative to CNY/USD pointed to rising pressure on the PBoC’s ability to maintain a stable CNY/USD rate.

With an over-valued currency and heightened risks about the outlook for China, market forces continue to put downward pressure on the Yuan. To maintain some semblance of currency stability in an environment where capital outflows continue, the PBoC is running down its large pile of foreign reserves. After peaking at just under USD 4 trillion in mid-2014, they currently sit at USD 3.2 trillion.

When the USD weakened over March-April and as the government increased capital controls, net capital outflows moderated. This provided some relief to downward forces on the Yuan and reduced the need to run down foreign reserves to support the currency, but a possible re-run of these risks, putting pressure on capital outflows, could easily return at some point.”