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[HONG KONG] Miles to go and promises to keep.
The words of the Robert Frost classic ring true for China's foreign-exchange reforms, with every economist, strategist and analyst interviewed by Bloomberg saying the yuan isn't anywhere close to being fully convertible even as it prepares to enter the IMF's reserves basket on Oct 1. A true free float is as far as a decade away, the yuan's top forecaster said, while JPMorgan Chase & Co produced a still-to-do list that includes the need to ease capital controls and cut back on intervention.
"If fully free floating means a fully convertible currency with no capital restrictions and no currency interventions at all, I do not foresee it in the next five to 10 years," said Bjarke Roed-Frederiksen, a Copenhagen-based economist at Svenska Handelsbanken, the yuan's most accurate forecaster as tracked by Bloomberg over the last four quarters.
Although the International Monetary Fund decided in November last year that the yuan was freely usable enough to become a global reserve currency, China's central bank retains strict control even as it pledges to increase the market's role.
The authority restricts onshore yuan moves through a daily reference rate and has been suspected of meddling with the mechanism when the moves don't suit its aims. It has also been seen guiding weakness against the currencies of its trading partners to try to help exports.
The People's Bank of China's daily fixing against the dollar limits the yuan's moves to 2 per cent on either side, which gives the central bank - rather than the market - overall control. The central bank sets reference rates against other currencies as well, including the euro, the Australian dollar and the British pound.
Yu Yongding, a former academic member of the PBOC's monetary policy committee, says authorities need to train the market to tolerate greater fluctuations. The central bank can hold off on intervention while allowing an undisclosed degree of swings against a basket of currencies, he said.
"It will take China three to five years to widen the yuan's daily band and trading hours before gradually reducing the role of the fixing," said He Xin, head of China trading at Societe Generale SA.
"China should increasingly let market forces play a bigger role in deciding the daily reference rate."
Despite repeated promises of a freer exchange rate, Chinese authorities have been suspected of stepping up intervention since they devalued the currency on Aug 11 last year. The PBOC fueled speculation that it was supporting the yuan last month, setting a series of stronger reference rates after the currency weakened beyond 6.7 a dollar for the first time since 2010.
A 6 per cent drop in the yuan this year against a 13-currency index has also fanned talk that the central bank is guiding trade-weighted weakness to help revive exports. The onshore yuan closed at 6.6375 in Shanghai Thursday.
Little change, for the moment. Interventions might become smaller in magnitude and less frequent, but they will remain and not just to smooth volatility, said Mr Roed-Frederiksen.
Chinese authorities have a long history of meddling in markets. When local stocks suffered a US$5 trillion crash last year, state-linked funds stepped in to support the market, only to watch share prices fall to new lows at the start of 2016.
"We believe a free-floating yuan is some way off," said Brad Gibson, a Hong Kong-based fund manager at AllianceBernstein LP, whose AB RMB Income Plus Portfolio fund has returned 16 per cent this year to beat 97 per cent of its peers.
"It is more of a medium-term development and we would suspect a very heavy hand by the Chinese authorities in the currency market as we go through this stage."
With outflows surging to an estimated US$1 trillion in 2015, China clamped down. It stepped up scrutiny of cross-border transactions and froze quotas for a program that lets individuals invest abroad. The nation doesn't appear to have a problem when the cash is coming in, though, with government-linked entities raising money offshore and bringing it home.
While the Communist Party's latest five-year plan proposes increasing the yuan's convertibility in an orderly manner, progress has been slow. The "come in, don't go out" approach hasn't helped efforts to internationalise the yuan, with the currency's share of global payments dropping to a two-year low of 1.72 per cent in June.
On Thursday, the PBOC indicated it was planning steps to address the concern, saying it plans to increase cross-border use under the current account and make it more convenient for overseas entities to issue yuan debt in the onshore interbank market.
"A true reserve currency needs free cross-border flows, while a full range of derivative products is essential to foreign investors for hedging," said Haibin Zhu, chief China economist at JPMorgan in Hong Kong.
"The PBOC needs to offer more currency products including swaps, and increase market liquidity by expanding the bond market."
The yuan's rate in Shanghai differs with that in Hong Kong, which is free of the mainland's capital controls. The gap was cited by IMF staff in August last year as meaning that the offshore rate can't be used as a perfect hedge for onshore exposure. The spread, which widened to an unprecedented 2.9 per cent in January amid turmoil ignited by a eight-day run of weaker fixings, has since narrowed.
Policy makers have punished speculation on the spread, pushing offshore yuan borrowing costs to as high as 66.8 per cent. It isn't wise to battle the PBOC by betting the yuan will weaken because the authority will manage sentiment and any declines will be gradual, according to China Merchants Bank.
"The aim is ultimately to unify the exchange rates," said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd in Singapore. "But before that can happen, the onshore yuan needs to be free floating, currency restrictions lifted and trading expanded to 24 hours seven days. Once they achieve a free float, there is no longer a reason to have an offshore yuan market."
The inclusion of Chinese equities and bonds in global gauges would go a long way in pushing the yuan's use. In June, MSCI Inc denied local stocks entry into its benchmark indexes, citing a 20 per cent monthly repatriation limit as a "significant hurdle" for investors.
While policy makers have allowed global funds greater access to the US$6.4 trillion onshore interbank debt market, investors flag restrictions such as a ban on onshore foreign-exchange trading, unclear tax rules and curbs on bringing home profits.
The nation is taking steps to open up its markets, and the results are showing. The benchmark 10-year sovereign bond yield has plunged to 2.69 per cent, the lowest since 2009, after overseas investors increased their holdings of onshore bonds in June by 47.7 billion yuan (S$9.6 billion) to 764 billion yuan.
Chinese authorities have since February allowed all types of medium- to long-term investors to access the interbank bond market, and said that approved fund managers under the Qualified Foreign Institutional Investors program no longer have to apply for quotas to invest onshore.
"With most advanced bond yields very low or close to zero, the Chinese bond markets offer significant yield pickups and depending on the reforms, could offer very good liquidity," said Rajeev De Mello, who oversees about US$10 billion as head of Asian fixed income at Schroder Investment in Singapore.
"There are still a few measures to iron out such as onshore currency hedging for bond investors."