All it takes is a quick phone call and a “yellow cow,” or an unauthorized money changer, will appear on a motorcycle in a matter of minutes, ready to unload the rolls of notes he’s stuffed in a waist pack. That’s how many people in China, locals and expats alike, buy foreign currency to bypass controls.
The changers were busy punching in numbers on their calculators in 2013. The value of the yuan hit the upward limit on the 1% trading band set by the central bank 41 times last year. It maxed out eight times in December alone, demonstrating the high demand on the still-closely controlled currency.
People’s Bank of China (PBOC) allows the yuan to appreciate or depreciate daily by 1% in either direction of a marker it sets. The bank, not the market, sets the marker on a daily basis. During intraday trading on the last day of 2013, the yuan hit 6.0507 against the dollar, an all-time high. It appreciated 2.9% against the dollar last year compared to a 1.01% gain in 2012.
Bold statements coming out of the central bank late last year helped push up demand for the yuan. PBOC Governor Zhou Xiaochuan said on November 19 that the bank would “basically” end normal intervention in the currency market, meaning it will stop massive purchases of US treasury bonds that keep the value of the yuan down.
The bank’s Deputy Governor Yi Gang went a bit further last week, saying that China’s currency was close to equilibrium and would not require more intervention.
If that’s true, and China intends to stop buying US treasuries on a regular basis, the value of the yuan should appreciate considerably this year and in the years to come as China’s trade surplus is set to rise too. The IMF says the country’s current accounts surplus will double between 2013 and 2017.
China’s increasing current accounts surplus puts pressure on the yuan to appreciate. Since China earned the reputation of the “world’s factory” in the late 1980s and early 1990s, policy makers have bought up dollar-denominated assets such as US treasury bonds, ramping up demand for the dollar and pushing down on the value of the yuan. A weaker currency makes Chinese exports more competitive.
Adding to this upward pressure on the yuan more recently is the central bank’s policy on tightening liquidity in the interbank market. Since June, PBOC has refrained several times from pumping cash into money markets, raising the cost of interbank lending. That has no doubt attracted those looking to arbitrage on interest rates, ANZ Bank said in a note to investors.
In Hong Kong, traders can get loans for offshore yuan at low interest rates, bring that money onshore and deposit it at higher interest rates, turning a risk-free profit on the hot money.
Under this mounting pressure, a halt to currency intervention should mean that growth in the value of the yuan this year. That is, if PBOC can stick to it. Mark Williams, chief Asia economist at London-based research firm Capital Economics, in a note to investors last week called into question China’s intention to stop buying US assets.
By Capital Economics’ count, China bought up about US$78 billion in foreign exchange in October, and then a similar amount in November. The bank has said the purchases were necessary to counteract the hot money that has poured into the country this year.
Still, the recent moves indicate that PBOC is far from weaning itself off such buy-ups. Capital Economics projected slowing appreciation of the yuan over the next two years: 5.9 yuan to the dollar at the end of this year, or 2.5% appreciation, and then just 1.7% in 2015 at 5.8 yuan to the dollar.
Other projections have varied greatly. In the face of the US Federal Reserve tapering its bond buying program, which has released trillions of dollars of easy cash into emerging markets since 2008, PBOC will look to stabilize the yuan against the dollar, researchers at Bank of America Merrill Lynch said in a note in December.
The bank also pointed out that, while much money may have crossed the Hong Kong border into China this year, speculation over appreciation of the currency onshore likely led to outflows into offshore accounts as well, something that would ease the central bank’s need to buy US treasuries.
ANZ expects “mild appreciation” in 2014.
Alex Fuste Mozo, chief economist at Andorra-based Andbank, said in an email that the yuan could appreciate by 3-3.5% annually for several years. Fuste Mozo looks to the market reforms for resource allocation as a signal that some state currency controls could be lifted. In November, the government pledged that the market would play a decisive role in the pricing of water, oil, power and transport.
“I interpret here, [market reforms] also in the FX arena,” he said in an email last week. The central bank seems to be on board with that. In an interview published in early December, PBOC deputy governor Yi Gang said many new reforms would extend to China’s currency. “Those who trust in the market,” he told a reporter “will have great innovation.”