Yuan's fall in line with forex-market trend

INSIGNIFICANT: The depreciation of the yuan versus the US dollar is in line with China's mechanism to realise the yuan's true value.


    Aug 18, 2015

    Yuan's fall in line with forex-market trend

    THE yuan's central parity rate against the United States dollar was lowered by 1.86 per cent last Tuesday and by a further 1.6 per cent the next day - the largest one-day and two-day falls, respectively, since 2005.

    One person's loss is often another's gain. The International Monetary Fund (IMF) welcomed the move, but some US politicians disliked it and branded China a currency manipulator.

    They want the yuan to be frozen without any fluctuations - while the US may use its currency to ease or tighten the supply of US dollars, change interest-rate levels and for other purposes.

    This is neither fair nor reasonable. What is desired by some US politicians is simply nonsense.

    China had adopted a managed floating exchange rate regime with reference to a basket of currencies. The People's Bank of China (PBOC) published the reference rates of yuan against the US dollar and other currencies based on the weighted average prices of foreign exchange (forex) transactions on the interbank forex market in the previous day's trading.

    The forex trading could fluctuate within a certain range with the reference rate - if the fluctuation range widened - so then the central parity rate would be realised. By virtue of this mechanism, exchange rates can be adjusted.

    As the US dollar had been strong versus other currencies - like the Australian dollar, Canadian dollar, euro and yen - over the past months, and US interest rates may be raised by the Federal Reserve as early as next month, demand for the US dollar has been increasing. It is not possible to keep the yuan as strong as ever if the exchange rate mechanism is observed. The adjustment is a direct reflection of the interbank forex market, rather than a signal for a currency war (as speculated by some people).

    In view of the depreciation of many foreign currencies by up to 30 to 40 per cent against the US dollar this year, the yuan's fall of 3 to 4 per cent against the US dollar should be considered minimal and insignificant.

    It should be interpreted as a temporary end to the strong yuan and not a major policy change by China in order to adopt a weak yuan policy. Should there be any speculative attack on the yuan, PBOC, with trillions of US dollar reserves, will be capable of defending the currency and defeating the offenders.

    As a responsible nation, China tried its best to keep the yuan strong during the 1997 Asian financial turmoil and the 2008 global financial crisis. This was despite its trading partners rushing to depreciate their respective currencies to support exports.

    In the face of a strong US dollar, China must follow the current trend of the forex market, and let the yuan depreciate along with other currencies versus the US dollar. This is in line with its current mechanism for realising the true value of the yuan.

    With the world's highest trading volume and second-highest gross domestic product (GDP), China relies more on trade than the US, which has the world's highest GDP and second-highest trading volume. That is to say, China's trade dependency ratio is higher than that of the US.

    Official statistics reveal that in the first seven months of the year, Chinese exports fell 0.9 per cent from a year ago due to a strong - probably too strong - yuan.

    If nothing is done to stimulate exports, China might have difficulty achieving this year's GDP growth target of 7 per cent. Compared with significant depreciation by other currencies, such as the yen, the recent adjustment in the yuan's central parity rate should be regarded as a prudent move. It is a decision which should have been taken a bit earlier.

    Devaluation and appreciation of the currency are a double-edged sword. They can bring both advantages and disadvantages to an economy. For example, a weaker currency may help boost economic competitiveness and exports.

    But it may also dent imports and cut corporate profit margins, a scenario which does not bode well for future development.

    In the case of yuan depreciation, meanwhile, Hong Kong consumers will benefit from less expensive products from the mainland. But the city may also become less attractive to mainland tourists. The best practice is, therefore, to have a stable forex mechanism responding to both domestic and international markets.

    IMF's comment on Wednesday was worthy of note. It said the latest adjustment in the yuan's central parity rate represents the central government's drive to give market forces a decisive role in the economy and quicken its integration with the global financial market.

    For Hong Kong, I believe that pegging the Hong Kong dollar to the yuan may be a wise option, particularly as One Belt, One Road - China's strategy to build up its ancient Silk Road and new Maritime Silk Road - moves forward.