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3rd LD-Writethru-Xinhua Insight: Yuan may stumble, but will not fall

Xinhua, August 12, 2015 Adjust font size:

Chinese yuan extended its decline on Wednesday but is unlikely to depreciate significantly as the central bank and stable fundamentals will not allow the currency to go into freefall.

The spot rate fell about three percent to its lowest level since October 2012 when the central bank reformed the exchange rate formation system on Tuesday. The central parity rate fell 1.6 percent, to 6.3306 against the U.S. dollar on Wednesday.

In a latest statement released on Wednesday, the central bank said there was no reason for the yuan to depreciate further.

A relatively robust economy, current account surplus and the internationalization of the yuan will bring stability, the People's Bank of China (PBOC) said. The economy maintained 7 percent growth in H1, creating sound conditions for the yuan to hold steady.

The surplus in goods trade was 305 billion U.S. dollars in the first seven months, a fundamental prop for the exchange rate.

An internationalized yuan and open financial sector have boosted the demand for the currency, which also helps stabilization, the PBOC said.

The PBOC also cited abundant foreign exchange reserves, stable fiscal conditions and healthy financial system. The bank plans to improve exchange rate formation with normal fluctuations and keep the rate basically stable.

Ma Jun, chief economist at the PBOC's research bureau, attributed the lower rate to a long-standing gap between the central parity rate and the previous day's closing rate on the inter-bank market.

He also said the shift is a one-off technical correction and should not be interpreted as an indicator of future depreciation.

UBS chief China economist Wang Tao, another depreciation denier, expects the government to remain cautious. "The upcoming special drawing rights (SDR) review is one consideration, and avoiding destabilizing depreciation expectations and capital outflow, a more important one," Wang said.

Deutsche Bank, with a baseline forecast that USD/CNY will be around 6.3 by the end of 2015, says since the government may want to prevent the market from building an expectation that the yuan will become a one-way trade again, there may be some volatility in the fixing and in the CNY spot market.

China International Capital Corporation (CICC) said there was no need to worry too much about the yuan's weakening.

The market might regain confidence in the yuan if the central bank guided the exchange rate to stabilize at current level after the pressure of depreciation diminished, CICC said.

As the depreciation will attract less money and lead to capital outflows, the central bank may inject liquidity with a cut in the reserve requirement ratio (RRR). Nomura China economist Zhao Yang expects one RRR cut and a benchmark interest rate cut this year.

MARKET-DRIVEN CURRENCY

The exchange rate tumble was triggered by an attempt to bring the central parity rate closer to the market consensus.

"This may lead to significant fluctuations in the short run but after a period of adaptation the intra-day exchange rate movements and resulting central parity fluctuations will converge to a reasonably stable zone," the PBOC said.

The market had anticipated some depreciation, and when the guiding rate was revised the market bridged the previously accumulated differences between the previous rate and the market rate.

The International Monetary Fund (IMF) described the central bank's move as "a welcome step" that allows market forces to have a greater role in determining the exchange rate.

"Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets," an IMF spokesperson said on Wednesday.

The IMF believes an effective floating exchange rate can be established in China within two or three years.

More flexibility and a bigger say for the market can only help the pursuit of membership of the SDR basket.

"The reform made the yuan more market-driven, laying a foundation for the free exchange of the yuan, " said Liu Weiming, an analyst at China Citic Bank. "It helps clear some technical hurdles for the yuan to join the SDR." Endit