China beats stability drum as Fed outlook risks yuan decline

If China is worried about the freshly hawkish Federal Reserve rocking the yuan, it isn’t showing – yet.

Leaders of the world’s second- largest economy conveyed a message of stability as the National People’s Congress began Sunday in Beijing. Central bank deputies Pan Gongsheng and Yi Gang emphasized that the currency market was steady, with Pan reinforcing that any yuan volatility would be “normal,” even if trading is affected in the short term.

“China’s main goal is to keep the yuan stable in the first half,” Li Daokui, a professor at Beijing’s Tsinghua University and former adviser to the People’s Bank of China, said in an interview on the sidelines of the NPC. “Conditions aren’t ripe for allowing more volatility.”

While stability pledges may be reassuring for other emerging markets, which are being anchored by Chinese policy amid shifting sands in the U.S., it could be a tough task.

With the Fed putting a March interest-rate hike in play over the past week, a turnaround in the dollar could test the PBOC. U.S. tightening erodes China’s yield advantage, stepping up depreciation pressure on the yuan and potentially stoking outflows just as policy makers seek continuity ahead of a rotation in the Communist Party’s leadership later this year.

The PBOC may be reluctant to keep up by raising its benchmark interest rate as that would endanger the budding economic recovery, with the 2017 growth target of about 6.5 percent coming with the hopeful “or higher” qualifier on Sunday.

Given the rebound in the economy is still nascent, China’s focus will be on controlling risk and deflating asset bubbles, said Zhou Hao, an economist in Singapore at Commerzbank AG. “This means that monetary policy will gradually tighten.”

China has so far managed to avoid an increase in benchmark borrowing costs, tightening conditions in money markets instead as it seeks to curb risks from an uptick in leverage.

Yi said the yuan will be basically stable in a reasonable range, the state-run Xinhua News Agency reported Saturday. He previously told Chinese media that monetary policy should be not too loose, nor too tight, as it seeks to stick to its “prudent and neutral” mantra. Yi said yesterday decision-making around rates will depend on the state of the domestic economy. Separately, the China Securities Journal cited Yi as saying that the yuan will remain credible and flexible against other major currencies and be stable overall.

With Fed Chair Janet Yellen basically locking in expectations for a March hike on Friday, and hinting at a more aggressive path beyond that, the PBOC’s middle road may become harder to tread, according to Bloomberg Intelligence economists led by Tom Orlik in Beijing.

The PBOC “will be faced with a choice between raising rates more aggressively – adding stress for indebted corporates – or accepting more pressure for yuan depreciation and capital outflows,” they wrote in a report Sunday.

Orlik also pointed to a change in wording about the yuan in Premier Li Keqiang’s work report as a sign officials may be ready to accept greater flexibility in the exchange rate.

Other analysts agree. While China will continue to target yuan stability this year, that doesn’t mean they’ll keep the currency rigid amid wider market volatility, said strategists at Macquarie Group Ltd. in Singapore.

Deputy Governor Pan said data will show the currency market stabilized in February and that foreign reserves remain ample. An update on the world’s biggest stockpile is due this week, with economists projecting a decline to USD2.97 trillion. That would also be the eighth straight monthly drop, the longest losing streak in at least two decades of data. Bloomberg