The global financial community waited patiently in the first half of the year for a widened trading band for the yuan. That allowance, which would have let the currency fluctuate to a greater degree on a daily basis, never came. Now attention has turned to a master plan for convertibility of the yuan. All eyes will be looking out for details on this at the Third Plenum political meet next month in Beijing.
International businesses have really honed that skill well – waiting on China, that is. Judging by the country’s forex purchases last month, they will need to keep waiting.
Suppressing the yuan and keeping exports cheap has been routine since China became a manufacturing powerhouse. The central bank soaks up excess dollars out of the international market in order to keep its value high and the price of the yuan down. As of August, People’s Bank of China (PBOC) had amassed about US$3.4 trillion in foreign currency reserves.
But in September, China vacuumed up dollars like they were going out of style. Data compiled by London-based Capital Economics show that the bank bought about US$70 billion, an astronomical figure and a stark deviation from months past. Purchases in July and August came to US$16 billion.
The buying spree pushed up the value of China’s dollar reserves by US$163 billion in the third quarter. Capital Economics called it one of the largest increases on record.
Back in the habit
For anyone perusing the figures, the immediate question is: “Why the sudden spendthrift ways?” Chinese customs officials might hate the answer.
About a year ago, an increasing number of traders started taking out low-interest loans in Hong Kong, bringing the cash across the border into China and exchanging it for yuan. They made low-risk profits on the exchange rate differentials all the while driving up demand for yuan with each exchange. In April, the government cracked down on the hot inflow of cash into the country. A huge drop in exports in June made that practice look all but over.
“It worked for a few months,” Kevin Lai, a senior economist at Daiwa Capital Markets in Hong Kong, said of the government’s attempt to stop the arbitrage. Data from Hong Kong point to a massive upsurge in this kind of arbitrage, driving demand for yuan and pushing the central bank to buy the whopping sum of dollars it did last month.
There’s more proof for an upsurge in arbitrage from Hong Kong. Throughout the region in late September, foreign reserves increased when the US announced that it would not taper quantitative easing as fast as once expected. Yet Hong Kong didn’t see much of an increase in holdings – likely because firms were borrowing cash and hauling it to the mainland again.
Looking at the August data for Hong Kong-China trade, Lai says China’s imports from Hong Kong were inflated by about US$8.5 billion, another indication that large sums of money were crossing the border but not necessarily for real trade purposes.
Such a great demand for yuan left China with few other choices than to buy up dollars to bring down the price of its currency.
A deeper question on PBOC’s September buy-up concerns the lengths to which China will go in order to control the yuan – especially during a time filled with expectations on liberalizing the currency.
Beijing claims companies are already registering to set up in the Shanghai free trade zone, where the yuan will ostensibly be fully convertible. The promise of liberalization there has attracted much attention, along with an equal amount of skepticism on how potent reforms in the zone will really be.
In November, the nation’s top policymakers will gather for the Third Plenum, a high-level meet where the direction of China’s reform will be discussed. A report released on Tuesday by HSBC says liberalization of the yuan should be a priority at the quinquennial meeting. Indeed, China Economic Review has also picked this out as one of the key issues that should be discussed at the plenum.
But the frantic purchase of foreign reserves last month reveals a government still far too reluctant to take its hand off the controls. “The launch of the free trade zone last month signaled that policymakers still see opening of capital controls as an important goal,” the Capital Economics report says. “But their actions underline that it remains a long way off.”
China seems perpetually on the cusp of some grandiose reform. The much publicized plenum and free trade zone have only served to raise expectations of seeing something big. However, the world should heed the PBOC’s hint and prepare to keep waiting.