PBOC Vice President Yi Gang; Image via World Economic Forum
PBOC Officials In Support Of CNY
Despite recent suggestions that the Chinese government will allow a more accelerated pace of CNY depreciation, most notably from Yu Yongding, recent statements from the PBoC instead continue to reaffirm a preference for a managed and gradual depreciation. In a newspaper interview published this week, PBOC Vice President Yi Gang highlighted CNY’s relative appreciation against most currencies since around the start of October despite its weakness against the US Dollar. Yi Gang emphasized the need to assess CNY against a broad basket and the USCNY cross rate will continue to be influenced by the divergence in the economic cycle and policy between the two countries.
Over the weekend the Wall Street Journal reported that the Chinese government is considering stricter controls on cross-border lending by Chinese banks and Chinese companies direct overseas investment. These reports followed an article published on the front page of the PBOC’s Financial Times last week which was titled “CNY Exchange Rate Movement Is A Natural Reaction To International FX Market Changes.” These two publications can reasonably be viewed as efforts by policymakers to protect against market stress and push back against the building fear that China might allow CNY depreciation to accelerate in the run-up to Trump’s inauguration in January next year.
PBOC Publicity Campaign In Swing
Indeed, it appears that the PBOC has been engaged in something of a publicity campaign over the past several days in support of the CNY. Speaking with Xinhua, PBOC Vice Governor Yi Gang noted that the CNY exchange rate demonstrates the characteristics of a strong currency. Whilst CNY has weakened against USD it has done so less than many developed currencies such as EUR, CHF, JPY and emerging currencies such as MYR, KRW, and MXN. Yi Gang argued that the accelerated increase in USDCNY of late has been driven by external factors such as expectations for accelerated US growth in the wake of Trump’s election and the consequent higher outlook for Fed rates. Yi Gang also added that Chinese FX reserves are abundant and that the country’s economic recovery and institutional reforms will drive a return of capital flows.
The PBOC is likely to continue to manage the path of CNY depreciation but allow the CNY to track the broader USD trend. In addition to direct FX intervention and verbal intervention, Chinese officials might also tighten controls and monitoring of cross-border flows.
The government is unlikely to stall outward direct investment as this would be contrary to the government’s One Belt, One Road strategy. However, the government might opt to impose greater scrutiny as a way of reducing disguised capital flight and to further pre-empt any backlash against Chinese Foreign Direct Investment in some recipient countries, specifically the US and the EU.
Capital Outflows Damaging China’s Balance of Payment
Among the channels for capital outflows, net outward foreign direct investment from Chinese corporates has sharply increased and contributes as much as 45% of the deterioration in China’s overall balance of payments over the last year which has almost totally mitigated the moderation in Chinese repayment of external debt.
Stricter controls on outward investment would likely be successful in reducing capital outflow for one or two quarters. However, beyond that horizon corporates would likely shift to other channels to continue to invest abroad. Over invoicing of imports and under invoicing of exports of goods and services would be the most likely method to facilitate continued foreign investment.
USDCNY is now back to levels not seen since early 2008 and is now on the path to test the next key structural resistance: 2008 high at 7.036.