China’s currency policy has been one of Donald Trump’s favorite targets, both before and since his election victory. The incoming US president has repeatedly called out China for artificially lowering its currency value to dump goods in the US—an accusation almost two decades out of date.
Yes, it’s true that China’s yuan depreciated steadily against the US dollar, by 7%, in 2016. And it could decline further to 7.3 yuan per dollar by year’s end (it’s currently at 6.93). But in recent years Beijing has been doing the exact opposite of what Trump claims: It’s been propping up the yuan’s value.
Most recently, fearing that its weakening currency could encourage more capital outflows, and that Trump could follow through with his pledge to label China a currency manipulator on his first day in the White House, Chinese policymakers have been engaged in an epic battle against bearish investors to safeguard the yuan’s value, trying to avoid the critical psychological level of 7 yuan per dollar in the near term.
Last week’s volatility in the offshore yuan market was a reflection of the long-running conflict between Beijing and investors. After the government tightened liquidity in Hong Kong early last week, the offshore yuan posted a record two-day rally of 2.5%. But then the offshore yuan promptly fell 1.1%—the biggest one-day decline in a year—as analysts advised traders to bet against the yuan right after the engineered spike.
Here’s how Beijing has been combating the vicious circle of yuan weakness and money outflows:
In recent years the Chinese central bank is widely believed to have swapped US dollars for yuan to prop up the domestic currency’s value, as reflected by China’s shrinking foreign exchange reserves.
China’s reserves fell for a sixth straight month in December, close to the critical $3 trillion level, as shown by the latest government data (link in Chinese). The drop in December was $41 billion, less than an analyst forecast of $51 billion. But the country’s total reserves now stand at a near-six-year low of just over $3 trillion. For 2016 as a whole, China’s foreign exchange reserves fell by nearly $320 billion, on the top of a record drop of $513 billion in 2015.
On Jan. 6, Hong Kong’s interbank overnight yuan borrowing rate (Hibor) almost doubled to 61% from a day earlier, the highest in a year. On the same day, the three-month interbank rate also hit an all-time high of 11%.
This means bets against the offshore yuan are quite expensive now. To bet on a decline in the yuan, investors typically “short” the currency by borrowing yuan in Hong Kong, selling them for dollars, and later buying them back at a more favorable rate. The higher the borrowing rate is, the more likely investors will cut themselves loose from the short position, making the yuan stronger.
The borrowing cost has been rising in recent few weeks thanks to the yuan’s short supply in Hong Kong, where investors trade a small pool of the Chinese currency more freely than on the mainland. Some investors believe Beijing might drain the liquidity (paywall) by directing state banks to buy up large quantities of yuan in the city whenever it’s deemed necessary.
Something similar happened almost exactly a year ago, when the overnight interbank rate hit a record high of 67% on Jan. 12, 2016. In the following two months, the offshore yuan posted a rally of nearly 5%.
As Beijing punished short-sellers in Hong Kong, it also considerably strengthened the yuan, largely in the domestic market. On Jan. 6, the Chinese central bank set its daily “fix” 0.9% stronger against the dollar. That was the biggest increase (paywall) since it unpegged the yuan to the greenback in 2005. The fix allows the onshore yuan to trade 2% on either side of it, and was at 6.8668 yuan on Jan. 6.
Chinese officials may order state-owned enterprises to temporarily convert some assets into yuan under the current account if necessary, as they are preparing contingency plans to prop up the currency, Bloomberg reported last week. Regulators have already encouraged some state-owned firms to sell foreign currency, according to the report.
Beijing sets an annual $50,000 quota for citizens to change yuan into foreign currency. As the annual limit resets for the year on Jan. 1, individuals’ purchases of the dollar will likely exacerbate capital outflows in the coming months.
At the start of this year, China’s foreign exchange regulator banned individuals (link in Chinese) from using their conversion quotas to buy overseas properties, stocks, or life- and investment-linked insurance policies that are not available on the mainland, while requiring extra documentation for buying foreign currency. It said the regulations were not new, but had not been strictly enforced in the past.
Hong Kong’s giant insurance industry previously played a big part in Chinese capital outflows, until Beijing restricted mainland investors’ payment methods in March 2016.
The Chinese central bank said on Dec. 30 (link in Chinese) that it will require Chinese financial institutions to report any cross-border transfers of 200,000 yuan ($28,800) or more, starting July 1. Chinese banks will also be required to report any domestic cash deposits, withdrawals, or transfers of 50,000 yuan or more when they are deemed suspicious.
Though they haven’t confirmed it directly yet, Chinese regulators have reportedly banned (as of November 2016) overseas investment above $10 billion, and mergers and acquisitions of more than $1 billion outside a Chinese firm’s core businesses, as well as overseas property deals by state-owned companies of more than $1 billion. The restriction might prevent acquisition deals like the headline-grabbing one made last March by Chinese insurer Anbang, which paid Blackstone Group $6.5 billion for a hotel portfolio that included Four Seasons properties.
Last year China’s overseas direct investment during the January-November period increased 55% year-on-year to reach $161 billion, according to the commerce ministry. Regulators have previously warned against fake merger deals that are being used by local companies to move assets out of the country.