Over the past four years, the gradual appreciation of the Chinese Yuan against the US dollar was considered a one way bet by currency traders. After being accused of being a "currency manipulator" on the global financial stage by its western counterparts, notably the US, Beijing realized that it could not keep its currency artificially depressed. For far too long had its goods gained a competitive advantage unfairly by
the means of an extremely undervalued currency.
The fact that China is slowing down to a more "normal" GDP growth rate is not new news. Until last week, the spillover effects of the emerging market (EM) currency sell off had not affected the Yuan. In fact, it was showing relative strength -- appreciating against the US dollar when all other EM currencies were selling off. It is also important to note that the Yuan was showing strength at a time when the Chinese stock market was trending downwards and the central bank could have intervened to stem its rise to support China's exports.
However, it was only last week that the People's Bank of China (PBOC) intervened in the foreign exchange market. It instructed the Chinese state-owned banks to buy dollars and drove the Yuan to a seven-month low. The Yuan has fallen around 1.1 percent against the US dollar since January. While such a drop is by no means a huge movement in the
currency markets, it should be viewed against the backdrop of the mere 2.9 percent appreciation the Yuan witnessed against the dollar in 2013.
According to currency strategists, the PBOC is trying to send out a strong message that the Yuan may soon be approaching its "fair" or "equilibrium" value and that betting on further appreciation of the Yuan is no longer a straightforward bet. It is also important to note that the PBOC is trying to widen the daily trading band (the maximum
intra-day movement that that take place). Currently, the PBOC sets a daily reference rate for the Yuan and allows its to fluctuate 1 percent (current trading band) from that set level. Chinese officials target to increase the trading band to 2 percent gradually over time.
The Australian dollar, a currency closely linked to the fortunes of the Yuan and copper have posted declines last week following the Yuan's decline. It will be interesting to see if this depreciation also affects other EM currencies as we head into next week.
Surely now with the PBOC intervention, the Yuan trade can go either way. Whether or not the Yuan has reached its fair value needs to be further analysed by economists. Inflation in China has run high in the past few years. Thus, it will be real appreciation of the Yuan against the dollar which must be looked at carefully.
For the time being, the decision to widen the Yuan's trading range fits into the long-term economic plan of Beijing. It has long wanted the Yuan to rival the US dollar for the reserve currency status. This move will bolster the Yuan's role in the international monetary system to a great extent.
(01.03.2014 Vatsal Srivastava is a senior market analyst. The views expressed are personal. He can be contacted at vatsal.sriv@gmail.com)
