China's IMF ambitions send warning signal to yuan short-sellers

[NEW YORK] There are plenty of things luring short-sellers to the Chinese yuan right now.

Growth is slowing. Capital is flowing out. And by some measures, the yuan is the most overvalued currency in the world.

Yet there's one big reason not to bet against it: The People's Bank of China is on the other side of the trade.

Chinese policy makers will do whatever it takes to ensure a stable exchange rate before the International Monetary Fund starts discussing the possibility of adding the yuan to the ranks of the world's reserve currencies in May, according to Barclays Plc and DBS Group Holdings.

They've already been tapping their almost US$4 trillion in foreign reserves to do this, spending an estimated US$33 billion in the first quarter to halt a slump that had sent the yuan to a more than two-year low in March.

While a weaker exchange rate would help boost exports and shore up the slumping economy, it'd undermine China's push to make the yuan a suitable currency for international trade and finance.

The inclusion in the IMF's so-called Special Drawing Rights is the centerpiece of President Xi Jinping's ambition to challenge the hegemony of the dollar and a global economic order dominated by the US and Europe.

"They definitely won't allow a yuan collapse," said Nathan Chow, a Hong Kong-based economist at DBS who sees a 90 per cent chance the yuan will be included in the SDR basket this year. "It's unwise to have sharp depreciation when you want others to hold the currency in their reserves."

TAPPING RESERVES

The yuan halted its four-month decline in March as Premier Li Keqiang and Central Bank Governor Zhou Xiaochuan expressed publicly their hopes for the yuan's inclusion in the IMF programme. The currency has erased this year's loss of as much as 1.2 per cent, trading at 6.2032 per dollar Wednesday after falling to as weak as 6.2763 on March 3.

The PBOC didn't immediately respond to a faxed request for comment.

The monetary authority is dipping into its foreign reserves to offset capital outflows and stabilize the yuan. Economists surveyed by Bloomberg estimate that the stockpile declined US$33 billion in the first quarter, extending the drop since June to US$183 billion.

SDR REVIEW

Created in 1969 to support the Bretton Woods system of fixed exchange rates, the SDR basket consists of the dollar, euro, yen and British pound, serving to supplement nations' official foreign-exchange reserves. The IMF will conduct the twice-a-decade review of the currency basket in October after an informal briefing in May.

"Ahead of the SDR review later this year, China will refrain from devaluing the yuan," Barclays analysts led by Mitul Kotecha and Jian Chang wrote in an April 2 note.

The Chinese currency, which became the world's fifth most- used in December, will remain stable this year, ending 2015 at 6.23 per dollar, according to median forecast of 58 analysts surveyed by Bloomberg.

While in the minority, some strategists including Albert Edwards at Societe Generale SA have called for a devaluation of the yuan to spur growth. Royal Bank of Canada predicts the currency will weaken about 7 per cent by year-end to 6.7 per dollar. Deutsche Bank AG's strategists are advising clients to sell the yuan using options.

GETTING EXPENSIVE

China's economic growth rate slowed to 6.3 per cent in February, below the official target of 7 per cent for 2015, while capital outflows totaled US$356 billion since the end of May, data compiled by Bloomberg show.

By at least one measure, the yuan is becoming expensive. The inflation-adjusted exchange rate against its major trading partners reached a record in February, after rising 34 per cent since the end of 2009, the most among 32 major currencies, according to the Bank for International Settlements.

"We are not done with the weakness yet," strategists including Perry Kojodjojo at Deutsche Bank wrote in a note on April 2. The yuan will resume its decline "in the absence of a stable economic outlook" and prolonged currency intervention, they said.

A weaker yuan could undermine China's push for the SDR membership. The IMF rejected the currency's candidacy for the reserve basket in 2010 because it wasn't "freely usable." Mr Zhou pledged on March 29 to further ease capital controls, saying policy makers will revamp currency regulation "relatively radically" this year. Instead of using the exchange rate, Chinese policy makers have relied on other tools to boost growth, including cutting interest rates and reserve requirements.

An SDR membership is among the "higher" objectives that dictates China's foreign-exchange policy, according to Stefan Hofer, the Hong Kong-based chief investment strategist at BNP Paribas Wealth Management, which oversees about 305 billion euros.

"It will be a major symbolic step," he said in a March 31 interview.

BLOOMBERG