[SHANGHAI] Chinese policymakers tried to assure world leaders last week that they have no intention of pushing the value of the yuan down further to gain a competitive advantage. Their most pressing task though is to persuade financial markets.
Investors are far from convinced that the Chinese government wants to hold the yuan steady for long following an unexpected devaluation in August and perceived policy flip-flops, which fuelled financial market jitters that the economy was in worse shape than Beijing had let on.
"It's very dangerous if the market keeps thinking the yuan needs to depreciate more," said a senior portfolio manager at an Asian asset management firm in Hong Kong. "The central bank has successfully stabilised the market for now," he said, declining to be identified because he is not authorised to speak publicly to the media.
"However, I do not think the market expectation of a weaker yuan has been changed and many people believe it will fall around 5 per cent this year." The yuan has already fallen 3 per cent against the dollar following the devaluation, which added fuel to a stocks' slump and flight of capital out China.
China's markets steadied at the end of last year following a flurry of measures by the government, then fell again in January.
For the past week or so, the central bank has held the yuan steady and Chinese officials at the Davos World Economic forum in Switzerland last week said the government had no intention to push the currency down, the latest in a series of similar remarks by China's officials, including Premier Li Keqiang.
DEPRECIATION, NOT DEVALUATION
While China is unlikely to conduct another one-off devaluation any time soon given the global market turmoil it sparked and the barrage of criticism over a perceived failure to communicate policy effectively, markets expect Beijing to allow the currency to fall.
China has spent heavily to discourage speculators - earlier this month state bank currency purchases drove yuan borrowing rates in Hong Kong to record highs - but markets where Chinese policymakers have less influence are pricing in a big depreciation against the dollar.
Offshore non-deliverable yuan forwards, a speculative instrument, are pricing in a 4 per cent fall one year ahead, up from just 2 per cent in mid October.
The pricing also suggests investors see a fall of around 1 per cent in March or April.
Spikes in onshore short-term borrowing costs in recent weeks - despite record cash injections by the central bank - suggest capital outflows are intensifying, some analysts say.
Cash demand rises ahead of the Lunar New Year holiday, falling in February this year, which the central bank acts to offset with temporary cash injections to the banking system. But some economists say this year's big injections - the largest in at least two years last week - reflect central bank attempts to steady domestic liquidity following currency intervention to offset capital outflows.
"While the central bank stated that the liquidity injection is to prepare for possible liquidity shock amid Chinese New Year season, we see that this is primarily to counter the strong capital outflows and the withdrawal of yuan liquidity due to FX market intervention," Zhou Hao, senior emerging markets economist at Commerzbank in Singapore, wrote in a client note.
To be sure, many investors believe the government is not opposed to a weaker currency despite the rhetoric. Gone are the days when Beijing was under international pressure to let the yuan rise as its economy notched up double-digit expansion.
Growth in 2015 was the lowest in more than two decades and is expected to slide further, while the dollar is likely to rise broadly as the United States raises interest rates.
Indeed, the yuan's fall since August is in line with a new policy to manage the yuan against a basket of currencies, but after many years in which it was managed against the dollar, investors are hesitant to accept the change in the absence of more details about how the central bank will manage the currency.
Financial markets need more "clarity and certainty", IMF Managing Director Christine Lagarde said at the weekend.
"I know there's a lot of scepticism out there," said Julian Evans-Pritchard, China economist at Capital Economics in Singapore. "But we think it's mainly a communication problem."
Chen Long, China economist at the Beijing-based consultancy Gavekal Dragonomics, said the new currency policy meant China may tolerate a deeper yuan decline against the dollar. "Its failure to clearly explain this policy is the main reason it has produced so much market turbulence," he said in a client note. "It is crucial for the PBOC to clarify what its definition of 'currency stability' really is," the note said. "We think the political reasons to maintain a very strong renminbi are not as strong as they once were."