China: China's currency plummets at the beginning of 2016 to a level last seen five years ago
January 21, 2016
Market forces gradually continue to determine the exchange rate in China, but the path to full liberalization is far from being smooth. Toward the end of 2015, China’s c renminbi continued to lose ground and, on 31 December, it traded at 6.49 CNY per USD, which was 1.5% weaker than on the same day in November. The renminbi, also known as the yuan, lost 4.6% of its value in annual terms in 2015. The fall continued as the economy entered into 2016. Following the 1.5% month-on-month depreciation in December, the CNY tumbled further and reached a fresh low on 14 January, when it closed the trading day at 6.59 CNY per USD. The last time China saw the yuan trading at that level was in February 2011.
The renminbi remains under pressure due to strong capital outflows amid concerns about the health of the economy. In 2015, China’s foreign reserves stood at USD 3.3 trillion; this was lower than the USD 3.8 trillion registered in 2014, a sign of capital flights. The strengthening of the dollar against other major currencies and the shift in the exchange rate regime also contributed to the currency’s weakness. The currency’s rapid depreciation took the markets by surprise, causing turmoil in the Chinese stock market and financial stress globally. This prompted the government to suspend trading twice, leading to confusion and exacerbating concerns about the state of the Chinese economy and its exchange rate policy.
Since 11 August 2015, when the People’s Bank of China (PBOC) unexpectedly devalued the CNY and established a new system to set the value of the Chinese currency more according to market forces, the PBOC has repeatedly stated that it wants to increase the flexibility and market-orientation of the exchange rate by referencing it more to a basket of currencies. However, the market has paid little attention to the shift. Commenting on the recent fall of the CNY and expectations of the currency, Tao Wang, Head of China Economic Research at UBS, said:
“We still see modest CNY depreciation of around 5% this year. Despite the recent sharp CNY move, we think the PBC is still trying to maintain the basic stability of the currency against the currency basket, which means continued gradual decoupling of the CNY from the USD. Based on our assumptions about the USD and other currencies, and about the Chinese authority's tolerance for USDCNY moves, we maintain our forecast of USDCNY trading at 6.8 at end-2016, implying a roughly 5% depreciation against the USD this year. This is likely to be achieved through staggered bouts of CNY depreciation against the USD, followed by periods of stability or even appreciation at times, with increasing two-way volatility. The magnitude and speed of these movements will in turn likely be determined by the USD's movements against other major currencies (especially the euro), timing of the US Fed's interest rate decisions, and other important agenda events such as the China-US Strategic Economic Dialogue or the G20.”
While the deprecation of the CNY has the potential to boost China’s faltering exports, if sustained, this situation could threaten the global recovery as China’s export rivals could also adjust their exchange rates, thereby entering into a currency war for a period.