China has been taking measures to stabilize the yuan by coordinating purchases through state banks and providing market guidance to bankers.
The moral suasion strategy represents a significant departure from Beijing’s previous approach when the currency was in a precarious position back in 2015.
In the past, the People’s Bank of China (PBOC) utilized official intervention as the central bank expended $1 trillion in reserves to bolster it.
In the midst of China’s economic instability and capital outflows this year, the PBOC adopted a distinct strategy to safeguard the currency. They effectively communicated their tolerance levels for selling to the markets, taking a unique approach.
Interviews with 28 market participants reveal numerous instances where regulators actively guided market participants through various coordinated measures this year to counteract significant downward pressure on the yuan.
The PBOC and State Administration of Foreign Exchange, the currency regulator, did not provide any response to the questions sent by Reuters via fax regarding its approach. Pan Gongsheng, the governor of PBOC, has previously emphasized the importance of ensuring stability in the foreign exchange market and avoiding excessive fluctuations in exchange rates.
The approach market participants and analysts outlined to Reuters has successfully averted a disruptive decline in the yuan.
Nevertheless, according to Reuters, this development has had a significant impact on various sectors of China’s foreign exchange market, resulting in a sharp decline in trading volumes and casting doubt on the yuan’s potential to establish itself as a global reserve currency.
“The current situation is much more intricate due to a combination of factors, including both domestic and global macroeconomic influences,” stated Eswar Prasad, Tolani senior professor of international trade policy at Cornell University.
He characterized the PBOC’s utilization of “unconventional methods to intervene in foreign exchange markets” as a means of “prioritizing” to prevent the yuan from depreciating too quickly.
Being the currency of the world’s second-largest economy and the largest exporter, the value of the yuan plays a crucial role in setting the prices of goods globally and influencing trillions of dollars in capital movements. It additionally acts as an indicator of the difficulties China faces.
According to an unidentified Chinese forex regulator, the value of the currency is primarily influenced by underlying factors. Currently, it is a result of China’s ability to counteract decoupling, which refers to Western attempts to decrease dependence on China’s economy.
According to ten traders interviewed by Reuters, significant indications began to surface in June when the PBOC’s daily yuan guidance, which sets the trading range for the day (also known as the midpoint), began to deviate from what the market anticipated.
The midpoint is calculated by taking into account the input of 14 different banks and is then compared to the previous day’s trading activity and overnight fluctuations. This process is designed to provide markets with a reliable indicator that can be used for making predictions.
By August, though, the significant difference between the midpoint and the traders’ estimates was interpreted by the traders interviewed by Reuters as an indication that the PBOC was not inclined to let the currency move in the direction that the markets were pushing it.
In Opposition to the Flow
Handling a currency can be an exhilarating rollercoaster. In 2015, China reduced the midpoint of the yuan by 2%, as stated by the PBOC, in an effort to align the trading band with market pricing. Due to concerns about additional devaluations, investors decided to offload Chinese assets, resulting in a sharp decline in stocks and the yuan.
This compelled the bank to tap into reserves in order to restore stability to the currency. Traders who spoke to Reuters revealed that this time, more precise and focused instructions were given to banks and participants in the currency market in order to manage the yuan.
Whenever the momentum appeared to be working against the yuan, state-owned banks discreetly stepped in as purchasers, according to the traders. This typically occurred near currency levels that held psychological importance and appeared to be intended to limit fluctuations. Traders informed Reuters that towards the end of May, they observed state banks intervening by purchasing yuan for two consecutive days, following the currency’s lowest point for the year 2023.
In December, the purchasing of yuan by state banks increased significantly following Moody’s announcement of a downgrade in China’s rating outlook. Individual traders struggled to gauge the magnitude of the purchasing activity, and Reuters was unable to verify if the central bank orchestrated this trading.
According to official data, there is no indication that the PBOC engaged in direct dollar sales, similar to what occurred in 2015. Nevertheless, market participants observed that banks offloaded dollars obtained through currency swaps, a phenomenon that would not be evident in the data above.
Meanwhile, smaller lenders have reportedly received heightened “window guidance” from regulators, which entails informal verbal recommendations for both banks and their clients to decrease their dollar holdings. This information comes from six sources in the trading and banking industry.
According to market observers, during June and July, the China FX Market Self-Regulatory Framework, under the supervision of the PBOC, instructed prominent state-owned banks to reduce dollar deposit rates. This move aimed to incentivize exporters and households to convert their dollar earnings into yuan.
Using the Telephones
Bankers have been facing similar levels of pressure as the yuan, which has experienced a decline of nearly 2.8% against the dollar this year, despite the fact that the benchmark dollar index has only lost 2.2%.
On September 8th, the Chinese currency reached its lowest point in 16 years. Several days later, managers from eight prominent banks were called to Beijing for a meeting with PBOC officials, as reported by five banking sources, two of whom were present at the gathering. According to three sources, it was communicated that companies looking to purchase amounts exceeding $50 million would require authorization from the PBOC.
Bankers were also advised to reduce spot trading, vary their dollar purchases, and avoid holding net long dollar positions at the close of each trading day, according to two sources.
Authorities also prioritized the surveillance of exporters’ foreign exchange transactions due to their significant currency reserves and influential impact on yuan fluctuations.
Recently, regulators have been reaching out to banks regularly, conducting surveys to gather information about the plans of their exporter customers. This has been happening quite frequently, as reported by officials from five different banks who spoke to Reuters. These calls were rare before, and surveys were only sent out once a month.
In October, the amount of yuan traded onshore experienced a significant decline of 73% compared to the level observed in August, reaching a record low of 1.85 trillion yuan. Analysts suggest that China’s bankers have responded to the request to decrease trading, especially in terms of purchasing dollars.
However, they also note that the central bank’s actions are having a dampening effect on the market. Currently, though, the currency has settled comfortably above the lowest point it reached in September, which was the weakest in 16 years.
Market participants are hesitant to confront the PBOC directly, but they are also not inclined to comply fully.
“I’ve been carefully observing the fluctuations in dollar prices this year, as I receive dollar payments on a regular basis,” said one exporter of electronic components based in Shanghai, surnamed Zhu. “Every day, people have been pondering: ‘Should I hold onto them, or exchange them for yuan?'” Up until now, she has set aside her savings with hopes of a more favorable exchange rate for her currency.