Yuan sinks to five-year low as PBOC surprises with weaker fixing

[BEIJING] The yuan sank to a five-year low after China's central bank set the currency's reference rate at an unexpectedly weak level, a sign that policy makers are becoming more tolerant of depreciation as intervention costs rise and economic growth slows.

The People's Bank of China cut its daily fixing to the lowest level since April 2011, weaker than the yuan's last onshore closing level. The currency fell 0.6 per cent in Hong Kong's freely traded market as well as in Shanghai, with both exchange rates dropping to their weakest levels since at least March 2011. The gap between the two rates reached a record before the start of onshore trading on Wednesday.

While China's defense of the yuan kept the currency stable for about four months after a surprise devaluation in August, the intervention led to the first-ever annual decline in the nation's foreign-exchange reserves. Official support for the currency has been more sporadic in recent months as the weakest economic expansion in a quarter century and rising US interest rates fueled capital outflows. Analysts at Macquarie Bank Ltd and Mizuho Bank Ltd said the central bank's currency policy is becoming harder to gauge.

"The market will be confused by what Beijing is trying to signal with the recent market intervention and today's fixing," said Nizam Idris, head of foreign-exchange and fixed-income strategy at Macquarie Bank in Singapore.

The central bank intervened in the currency market on Tuesday to prevent excessive volatility, said a person with direct knowledge of the matter. A few major Chinese banks sold US currency when the onshore yuan dropped to around 6.5460 per dollar on Wednesday, but the offerings weren't stable or constant, according to traders who asked not to be named.

The offshore yuan declined to 6.6964 per dollar as of 3:46 pm in Hong Kong, while the onshore rate was 6.5523, near the weakest since March 2011. The rate in Hong Kong fell to a record 2.2 per cent discount versus that of Shanghai prior to the start of onshore trading on Wednesday.

The PBOC, which shocked global markets with its Aug. 11 yuan devaluation, said at the time that it was revamping the fixing system to give market forces greater sway. While allowing the yuan to depreciate may help the Chinese economy, it risks spooking global markets, according to Japan's Resona Bank Ltd.

"This isn't good for the rest of the world," said Koichi Kurose, Tokyo-based chief market strategist at Resona Bank. "Until China stops weakening the yuan, global markets will struggle to stabilize. The Chinese authorities may be trying to prop up the economy by boosting exports, but while that will help one part of China's economy, it comes at the sacrifice of someone else. Japan is an easy victim of such policy, given the overlap in many industries."

Yuan swings tend to impact currencies and export prospects across Asia, with China being the biggest trading partner of economies including South Korea and Taiwan. The Bloomberg- JPMorgan Asia Dollar - which tracks the region's 10 most-used currencies excluding the yen - reversed a daily gain immediately after the PBOC announced the cut to its yuan fixing and fell as much as 0.4 per cent.

A report next week is projected to show Chinese exports shrank for a sixth straight month in December, according to the median estimate in a Bloomberg survey of economists. The private Caixin Media and Markit Economics Chinese services gauge fell to a 17-month low of 50.2 in December, according to a report released Wednesday.

The yuan has "limited" room for further depreciation as slumping energy prices will help boost the current-account surplus in China, the world's second-largest importer of oil, and offset capital outflows, according to Goldman Sachs Group Inc. Low crude prices may prop up the excess to about $360 billion this year, a level last seen before the global financial crisis, Goldman analysts led by Robin Brooks wrote in a report on Tuesday. A relatively strong export market compared to other developing nations also suggests the exchange rate is fairly valued, according to the report.

The PBOC cut its reference rate by 0.22 per cent on Wednesday to 6.5314 per dollar, weaker than both Tuesday's 4:30 pm level as well as the end-of-the-day rate. While onshore trading hours have been extended to 11:30 p.m., the monetary authority has said it will continue to view the 4:30 pm price as the closing level. Authorities said in August they would use factors including the last closing level and movements in major currencies when setting the reference rate.

"The fixing today flags China's policy risks," said Ken Cheung, a Hong Kong-based strategist at Mizuho Bank Ltd. "It looks like that they set it in an arbitrary way and the mechanism is not consistent with their policy guidelines. This obviously undermines the PBOC's policy credibility and investor confidence in the China market."

BLOOMBERG