Yuan may stumble, but will not fall

Photo taken on March 16, 2014, shows yuan (central) and other currencies in the picture. [Photo/IC]

BEIJING -- 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 US 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 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.