BEIJING (Reuters) - Long accused by critics in the West of keeping its exchange rate undervalued, China may now be tip-toeing onto the other side of the currency trade to sell dollars and ward off depreciation pressure on the yuan.
Traders and analysts say that any intervention by the People’s Bank of China has been small, barely enough to make a ripple in the market, but that it will show through with a drop in the country’s stockpile of foreign exchange reserves.
And few think the central bank will need to support the yuan for long, because China’s trade surplus is likely to rebound from the depressed level in February that may have prompted the move.
But the possibility that China has sold some forex reserves to keep the yuan steady flies in the face of charges that it has consistently suppressed the currency’s value.
It also all but rules out any concern that Beijing might engineer a significant depreciation to support struggling exporters at the same time as its neighbours’ currencies weaken.
Instead, it points to a government that is true to its word about wanting a stable yuan, at least against the dollar, whether the day-to-day pressure is for appreciation or depreciation.
“If this were a market-determined exchange rate, it would now be weakening, because the overall balance of payments looks to be in deficit, but it is not weakening,” said Paul Gruenwald, ANZ’s Singapore-based chief economist for Asia.
“The implication is that authorities must be selling their dollar reserves in order to stabilise the USD-CNY exchange rate,” Gruenwald, a former International Monetary Fund official, said.
Analysts estimate capital outflows from China were largely balanced in the fourth quarter and in January by inflows from its yawning trade surplus, negating pressure on the exchange rate.
But a surprise slump in exports in February dragged the surplus down to $4.8 billion (3.4 billion pounds) and, if capital outflows were more or less constant, easily tipped China’s balance of payments into a deficit on the month.
Despite the current account fluctuations, the central bank kept the yuan on a remarkably tight leash, even by its standards, in February, locking it at about 6.835 to the dollar.
An analyst in Beijing, who spoke on the condition of anonymity because he is not authorised to speak to the media, said he had seen downward pressure in intraday trading that had required the central bank to wade in.
“I think they are selling every once in a while, but not necessarily consistently,” he said.
The central bank may have sold $1 billion or so on several occasions to maintain the yuan’s value in its narrow range — small enough to go virtually undetected, he added.
Financial markets expect the stability to endure, with non-deliverable forwards implying yuan depreciation of just 0.65 percent against the dollar over the next year.
China caused a stir in December by letting the yuan fall to the bottom of its trading band against the dollar on four straight days, but then quickly guided it back up, alarmed in part by the potential for capital outflows.
Many saw the brief yuan drop as a shot across U.S. bows. Beijing was reminding Washington that it was doing it a favour by keeping the yuan stable at a time when the dollar was soaring against most other currencies.
One way to demonstrate the central bank has intervened is to examine changes in China’s forex reserves. But extensive assumptions are first needed about the composition of reserves — a state secret — as well as how the central bank accounts for asset price and exchange rate fluctuations.
After controlling for those changes, any net drop in forex reserves, alongside broad stability in the exchange rate, would point to the central bank having sold dollars and bought yuan.
The trouble is that valuation swings can be massive. Paper losses on non-dollar assets and U.S. bond prices, for example, probably explained January’s record monthly drop in reserves, disclosed by Reuters.
Another big fall in February, when valuations should have steadied, would furnish clearer evidence of capital outflows.
Even so, the PBOC has plenty of ways to cloak reserve shifts, so drawing definitive conclusions is fraught with uncertainty.
Another key indicator of aggregate currency flows, under both the current and financial accounts, is monthly data on new yuan positions for forex purchases by the PBOC and commercial banks.
In January, the last month for which data is available, the amount of forex bought totalled 141.4 billion yuan (14.5 billion pounds), down sharply from 654.1 billion yuan in January 2008. If net new yuan positions turned negative in February, it would be a strong sign that the central bank had propped up the yuan.
“The figures show a clear trend that money flowing into China began to drop sharply from the fourth quarter,” said Liu Junyu, a debt market analyst at China Merchants Bank in Shenzhen.
With the economy still geared toward exports, analysts expect China’s trade surplus has probably rebounded from the abrupt narrowing in February.
Moreover, since the current account surplus, not speculative cash, has been the main driver of China’s foreign reserves, few think that a wall of “hot money” is now set to leave the country.
“Despite the smaller capital inflows, China is in no danger of seeing a massive capital outflow,” said Wang Haoyu, an economist at First Capital Securities in Shenzhen. “The yuan will still see appreciation pressure in the long term.”
And as the World Bank noted in its quarterly update on the Chinese economy released on Wednesday, Beijing has a virtual fortress in its $2 trillion of foreign reserves to defend the yuan under extreme — and extremely improbable — circumstances.
Editing by Kim Coghill