China says no reason for more yuan depreciation

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Backed by a mighty $3.65-trillion (U.S.) in reserves, China on Thursday judged the run on its currency complete.

And so it was – at least for a day.

In a rare morning briefing, People's Bank of China assistant governor Zhang Xiaohui said the yuan had been over-valued by about 3 per cent. It has now successfully corrected, leaving no more reason for it to continue depreciating, he said. Ma Jun, the bank's chief economist, said in separate comments to state media that the bank was fully capable of intervening directly to stop the yuan's tumble.

The reaction was swift. Within hours, the yuan was holding fast to the daily mid-point set by the central bank, a change from the previous two days of heavy downward pressure. By early evening in China, it was trading at 6.3972 yuan to the U.S. dollar, a fraction below the set point around which China allows daily trading within 2 per cent up and down.

The calm came after two days of global financial turmoil sparked by a series of cuts to the yuan that raised fears of a currency war and underscored the growing weakness in the Chinese economy.

The stability Thursday was in part manufactured, after Chinese authorities ordered the purchase of billions of dollars in their own currency and instructed banks to halt certain dollar-yuan trades, suggesting direct state management of the day's trade. The country's vast foreign reserves give it massive power to sway the yuan.

"Maybe they've engineered it," said Tim Condon, managing director and head of research for Asia with ING Financial Markets. But a halt to the turbulence is "what they're looking for. That's the indicator that the currency is subject to two-way risk."

Currency analysts and economists said the yuan still has farther to fall, with predictions ranging from 2 per cent to 10 per cent.

But on Thursday, there were indications the broader market was prepared, at least temporarily, to take the Chinese authorities at their word. Newly confident traders bid up stocks on China exchanges, and pushed up prices for industrial metals like copper, aluminum and zinc. Markets in Europe also opened strongly, with France's CAC 40 up 1.6 per cent.

The gap also narrowed between the offshore yuan and its onshore counterpart, an indication that the yuan is now more fairly valued – although the gap remains wider than in previous weeks. (China's restrictions on movement of the yuan across its borders means it trades separately inside and outside the country.)

"It suggests the market panic is taking a breather, at least for a moment," said Andrew Wood, a BMI Research analyst who focuses on Asia country risk.

Some of that came after the central bank sought to allay market suspicions that Chinese authorities have deliberately sought to lower the yuan as a sop to the country's ailing exports. Deputy governor Yi Gang on Thursday specifically addressed a widespread belief that China was aiming for a 10-per-cent devaluation, calling it "nonsense" and "totally unfounded."

That "alleviated some investors' concerns," said Sue Trinh, senior currency strategist with Royal Bank of Canada in Hong Kong.

She and others nonetheless believe the yuan remains overvalued – and that Beijing still has reason to slide it downward.

"Chinese growth is decelerating and the government's 7-per-cent GDP growth target for 2015 is looking rather optimistic without the help of further stimulus," Ms. Trinh said. That will likely entail further cuts to lending rates, but also "the exchange rate as part and parcel of that," she said.

She expects another 2.2-per-cent fall in the yuan by the end of 2015, though that is a slim change relative to the 2.9-per-cent drop on Tuesday and Wednesday. On Thursday, it slid another 0.5 per cent relative to the U.S. dollar, based on the midpoint set by the central bank.

Chinese observers credited the bank for moving against the panic, and said Beijing is acting no differently from any other nation.

"A foreign-exchange rate is simply a tool. No matter the country, they all act according to the needs of their own economic development," said Huang Weiping, a professor of economics at Renmin University.

But China has made significant steps toward freeing its currency from government control, he argued. "Our system is called a managed floating exchange rate. What constitutes a 'reasonable' level of depreciation is up to the market and economic situation," he said.

He suggested that reaction to the yuan devaluation this week has been overblown. The U.S. dollar, after all, has fallen nearly as much against the Euro in the past week without uproar.

"People are too sensitive now," Prof. Huang said. "Their minds are too fragile."

– with reporting by Yu Mei