China can't afford to let yuan slide quickly

New York

CHINA, like much of the world, is beefing up monetary stimulus to boost its economy. Yet, unlike its peers, it probably won't let its currency depreciate to help.

Sustained weakness in the yuan would make it more expensive to repay the US$1.1 trillion of debt the Bank for International Settlements estimates is owed by Chinese companies. As a result, China has to offset interest-rate cuts and other easing measures with steps to curb the yuan's 2.9 per cent slide from its peak about a year ago.

The quandary has made the yuan one of only two major currencies that forecasters surveyed by Bloomberg expect to strengthen versus the dollar this year, the other being Mexico's peso. Any gains would risk blunting China's stimulus and hurt an economy that's already slowing by making exports less competitive just after they suffered a surprise drop.

"It's a dilemma," Claudia Calich, a money manager in London at M&G Ltd, which oversees about US$1 billion of emerging-market assets, said Friday by phone. "They can't afford to let the yuan depreciate quickly because of the concerns about dollar debt. The authorities will perhaps slowly guide the yuan lower, but not in one go. It's quite a delicate balance." The yuan's offshore rate, the one most commonly used in international trading, slumped to a 27-month low of 6.2899 a dollar on Jan 30, compounding last year's record 2.7 per cent drop.

The losses won't continue, according to strategists surveyed by Bloomberg. The median of more than 30 forecasts puts the onshore yuan 1.5 per cent stronger by the year-end at 6.15 against the greenback, after closing at 6.2405 on Friday. M&G's Ms Calich is more bearish, predicting a decline to 6.50.

The yuan's recent slide was spurred by a slowdown in the world's second-biggest economy and the monetary accommodation designed to address it. Gross domestic product grew 7.4 per cent in 2014, the slowest pace since 1990. Exports fell 3.3 per cent in January, after economists anticipated a gain.

In response, China reduced the amount of reserves that banks have to keep on hand earlier this month, after cutting its benchmark interest rate in November for the first time in two years. Economists surveyed by Bloomberg expect the People's Bank of China to lower its 5.6 per cent lending rate to 5.25 per cent by year-end.

The PBOC has been trying to balance the need to buoy growth and efforts to contain a debt pile that's almost doubled in six years. The BIS, based in Basel, Switzerland, said in a report in January that China accounts for the biggest share of international borrowings in dollars, amounting to US$1.1 trillion.

"China's economic fundamentals suggest more policy easing, but they also want to keep the yuan decline under control so as to allow an orderly unwinding of debt and not to infect the market," Banny Lam, the Hong Kong-based co-head of research at Agricultural Bank of China International Securities Co, said by phone on Feb 12. "I see more reasons arguing for a mild yuan drop or even a stable exchange rate, rather than a sharp depreciation." UBS Group predicts the central bank will cut reserve requirements at least twice more before the end of this year - with the first coming in March or April - while taking measures to limit the yuan's losses to 3 per cent this year, Hong Kong-based economists Donna Kwok and Wang Tao wrote in a Feb 10 report.

A gradual depreciation would help stem the tide of cash that's fleeing the nation, the economists wrote. A net US$324 billion flowed out of China in 2014, not counting foreign direct investment, swinging from inflows of US$56 billion the previous year, UBS estimates.

The PBOC has been forced to walk a tightrope on its currency policy before. Officials encouraged the yuan's losses last year by lowering the reference rate they set daily. They buy or sell foreign currency to keep the yuan within 2 per cent of either side of that benchmark.

Policy makers then switched tactics, boosting the rate in five of the past six months in a sign they thought the yuan had fallen far enough. The yuan's market price reached the weakest-ever level versus the daily fixing earlier this month, data compiled by Bloomberg show.

China has no shortage of foreign cash to spend on manipulating the yuan in this way: its US$3.8 trillion of foreign-currency reserves are the world's largest.

That war chest, combined with an ambition to promote the yuan as a currency of global trade, will allow the PBOC to limit any decline caused by monetary easing to 3 per cent, according to Roy Teo, a Singapore-based strategist at ABN Amro Group.

Since the start of last year, China has appointed yuan- clearing banks in cities from London and Frankfurt to Sydney.

"The PBOC has large foreign-currency reserves to defend volatility and weakness in the yuan," Mr Teo said on Feb 11 by phone. "Increasing use of the yuan as a trade-settlement and reserve currency will also provide stable demand." BLOOMBERG