By Kyoungwha Kim
The yuan’s worst quarterly performance on record is raising the risk of capital flight.
China’s currency has slumped 2.9 percent since the end of March, the most since the nation unified the official and market rates at the start of 1994, to trade near its lowest level in five years. Losses deepened after the U.K.’s vote to secede from the European Union led to a jump in the dollar and dented the outlook for Chinese exports.
After turmoil in its currency and stock markets in the past year shook investor confidence, China stopped granting quotas for residents to invest overseas and clamped down on illegal fund transfers to restrain capital outflows. Policy makers are trying to guide the currency lower versus its trading partners as the economy slows while simultaneously damping expectations of faster depreciation. Goldman Sachs Group Inc. warned in a June 29 note that metals investors are concerned China may sharply weaken its exchange rate.
“We see a rising risk that capital outflows could pick up again causing negative headlines and adding to the fragility of current market sentiment,” said Allan von Mehren, Copenhagan-based chief analyst at Danske Bank A/S. “We expect the depreciation pressure on the Chinese currency to continue over the coming years.”
The yuan fell 0.08 percent to 6.6435 a dollar as of 6:19 p.m. in Shanghai on Thursday. It dropped as much as 0.26 percent earlier after Reuters reported that China’s central bank is prepared to allow a drop to 6.8 this year. Mizuho Bank Ltd. described the target claim as not “so plausible,” saying that the yuan’s weakness against a trade-weighted gauge gives the PBOC little reason to depreciate against the dollar.
The PBOC said in a statement on its website that some media reports on the yuan exchange rate misled, disrupted normal operations of the foreign-exchange market and encouraged speculative shorting of the currency.
The yuan, which is trading near a five-year low, is forecast to drop to 6.70 by year-end, based on the median estimate in a Bloomberg survey. It has declined 3.2 percent this quarter and 5.9 percent this year against a basket of peers, while the offshore yuan has lost 3 percent versus the greenback in the past three months. The authorities intervened via banks to support the offshore yuan on Wednesday morning, according to people with knowledge of the matter.
There is plenty of evidence that local investors want out of China, while foreigners have so far shown little appetite to jump in.
A program allowing some domestic and Hong Kong mutual funds to be sold on either side of the border has seen about 37 times more money leave China than enter so far this year. A link between the Shanghai and Hong Kong stock exchanges has to date enabled southbound outflows that are 39 percent more than the amount that’s moved north. In the first quarter, Chinese residents poured a record HK$13.2 billion ($1.7 billion) into Hong Kong’s insurance products, a popular way to move funds offshore.
There are “fears in the market over a sharp devaluation in China,” Goldman analysts wrote in the note summarizing views from Chinese metals traders, producers and investors.
The nation’s 10-year bond yield of 2.86 percent is the highest on offer in the world’s five biggest economies and compares with 1.53 percent in the U.S. and negative rates in Japan and Germany. The Shanghai Composite Index of shares has lost 17 percent this year, making it one of the five worst-performing markets globally.
The People’s Bank of China will probably step up intervention to limit declines in the yuan, according to Nordine Naam, global macro strategist at Natixis SA in Paris. Central bank support for the currency has led to an $800 billion decline in the nation’s foreign-exchange reserves over the past two years.
"Given risk aversion, the dollar will continue to rise against most emerging-market currencies including the yuan," Naam said. "The PBOC will intervene from time to time to reduce volatility."
The yuan gained 0.3 percent in the last two days as panic ebbed over Brexit, the biggest advance in almost a month, while the offshore yuan rallied 0.5 percent late on Wednesday.
Ken Cheung, an Asian currency strategist at Mizuho Bank Ltd. in Hong Kong, says investors shouldn’t bet on a repeat of March’s rebound, when the currency surged the most since 2010 after a January rout.
“We do not look for a relief rally in the near term as seen in early March," Cheung said. "Any rally should prove short-lived before the market gets a clearer picture of the development in Europe.”