Yuan enters new era with freer float

Fluctuations in the global market will keep renminbi dealers on their toes

Gone are the good old days when speculation on the Chinese yuan simply referred to acquisition.

Now that the decade-long expectation of appreciation is in tatters, traders will have to use more brain than brawn if they want to keep themselves in the game.

While the central bank has always preached the idea of a free-floating yuan, the People's Bank of China finally practiced it by doubling the currency's daily trading band to 2 percent on either side of the daily reference rate.

Zhou Xiaochuan, the central bank governor, has been pushing the idea for years, but traders really started to embrace it this time as their long positions suffered badly from a nosedive in the yuan's exchange rate.

The yuan lost 1.4 percent in Februa-ry along with another 1.2 percent lost so far in March, following 10 years of appreciation.

Morgan Stanley estimated that $150 billion of redemption forward contracts - a main tool to bet on the yuan's appreciation - remains in the market.

And, assuming contracts are 24 months in tenor, investors will see about $4.8 billion in total losses for every 100 basis points the yuan reaches above the level of 6.20 per dollar.

But what really caused them to rethink their strategy were remarks by another governor from the other side of the globe.

US Federal Reserve Chairwoman Janet Yellen on March 21 raised the possibility of an earlier-than-anticipated rise in US interest rates next year.

Yellen says a further cutback on the bond-buying program, by $10 billion to $55 billion a month, and adjusting its guidance on interest rates. She adds that the "considerable period" between the end of the Fed's economic stimulus program and the first rate increase could be six months, meaning that the first rate hike could happen as early as spring next year.

Higher interests rates in the US, analysts say, would reshuffle the pattern of international fund flow in place since the global financial crisis in 2008, driving funds back to dollar assets and weakening emerging market currencies, including the yuan, against the greenback.

After Yellen made the comments, the yuan continued to weaken against the dollar, trading as low as 6.22 at one point, its weakest level in more than a year.

"The yuan has gone from being a most attractive carry trade bet in emerging markets to the worst in two months as the central bank's efforts to weaken the currency have caused volatility to surge," Geoffrey Kendrick, head of Asian currency and rates strategy at Morgan Stanley, said at a news conference in February.

"Implied volatility in the currency rose in February by the most since May, when the Fed first signaled plans to cut stimulus."

Shen Jianguang, Hong Kong-based chief economist with Mizuho Securities Asia Ltd, wrote in a commentary on March 25 that the yuan has entered a "new era of two-way fluctuation".

Room for appreciation is "very limited", he wrote, given that China's trade surplus has been shrinking, labor costs are rising, and it has already strengthened by more than 40 percent against the dollar since 2005.

Room for depreciation is limited, too, as the direction for fund flow is still inbound, and China's economic growth is still one of the world's fastest despite its recent deceleration.

"Two-way fluctuation against the US dollar will happen more frequently and in a bigger range this year, while the yuan will remain basically stable against a basket of currencies," Shen says.

Bank of China Ltd says in a report that the yuan's recent decline will be short-lived and that China's trade surplus and huge foreign exchange reserves will support the currency's long-term appreciation.

Nathan Chow, a Hong Kong-based economist with DBS Bank Ltd, says that the recent yuan weakness and narrower onshore-offshore yuan spread are unlikely to reverse the currency's increasing global role in trade finance activities.

gaochangxin@chinadaily.com.cn

(China Daily Africa Weekly 03/28/2014 page21)