No cause for alarm, free-market exchange rates fluctuate. Recent weakness in the yuan is viewed as a natural step in the evolution toward becoming a world reserve currency.

The Year of the Horse started with the exchange rate of the Chinese yuan galloping downhill.

The once seemingly unstoppable appreciation of the yuan began going into reverse on February 18, touching a ten-month low of 6.1808 per US dollar last Friday.

The yuan has lost more than 2 percent against the dollar since January 14, when the yuan hit a 20-year-high of 6.0406.

This reversal goes beyond matters of mere high finance. The declining exchange rate has affected many ordinary consumers, much to their surprise.

An office worker surnamed Chen went for a holiday abroad before the Chinese New Year and spent some dollars while overseas. She waited too long to pay off her credit card bills.

“As usual, I waited for the deadline because later has always been cheaper,” said Chen. “I could have saved about 100 yuan (US$16.31) for every thousand dollars I spent if I had acted sooner.”

But Chen is among many who believe the yuan will rise again.

“Everything needs a rest,” Chen said.

Under control

Financial authorities and economists are interpreting the yuan’s new trend as a sign that everything is under control.

The State Administration of Foreign Exchange called it a “normal” reaction amid recent cash withdrawals from emerging markets and said the possibility for large and continuous outflows of foreign capital is “relatively small.”

The foreign-exchange watchdog said two-way volatility in the yuan is likely to increase as the Chinese market gains strength.

Economists attributed the depreciation to economic data pointing to slower industrial activity, to concerns about financial stability amid quick expansion of trusts and to withdrawal of foreign capital from emerging markets after the US Federal Reserve started paring back its monetary stimulus.

The message Chinese officials want to send is that the depreciation of the yuan is orchestrated and under control.

“We believe the recent yuan depreciation is supported by a shift in policy stance,” said Zhu Haibin, JPMorgan’s chief China economist. “In particular, the central bank would like to revert to a two-way volatility regime and to mitigate the near-term pressure of capital inflows.”

The yuan was one of the best performing currencies in 2013, appreciating by 3 percent against the US dollar — about 7 percent in terms of the real effective exchange rate, or a weighted average exchange rate with major trading partners, according to the investment bank.

The fast appreciation of the yuan in real effective terms placed heavy pressure on exporters and changed market sentiment from 2012, when the yuan barely moved against the US dollar.

Because of fast appreciation and relatively high interest rates, banks in China purchased 2.78 trillion yuan of foreign exchange in 2013, nearly 6 times more than in 2012.

Over the same period, China’s foreign-exchange reserves added another US$500 billion to US$3.82 trillion.

Last November, the People’s Bank of China said that there is “no longer any benefit” from increasing the forex reserves.

Financial risk

Continuous currency inflows could damp the central bank’s efforts to contain credit expansion and rebalance the economy. Excessive US dollar assets are seen as adding to financial risk, and a strong yuan hurts exporters.

By allowing a relatively sharp depreciation, the central bank may be testing new ground in its long-term aim to turn the yuan into an international reserve currency.

“The central bank never really wants too much yuan appreciation,” said Yao Wei, an economist with Societe Generale. “What matters is how it manages the currency.”

Yao said that to make a real difference, the central bank should take bolder reform steps, such as moving from daily to weekly or even monthly settings of the reference rate and widening the band in which the currency is allowed to trade against the dollar.

China currently allows the yuan to trade between 1 percent on either side of central bank’s daily reference rate. Zhu with JPMorgan said he expects the band to double in the next two or three months, when the official rate and trading rate converge and when capital flow is balanced.

Resuming appreciation

Most financial institutions are still predicting that the yuan will resume a stable appreciation this year.

The central bank signaled further currency reforms in four documents it issued in the past two weeks related to the newly formed Shanghai free trade zone.

They outlined operational details, including cross-border yuan lending and fully liberated interest rates for foreign currencies.

Foreign interests are watching closely.

European Central Bank executive board member Yves Mersch said last week that the currency may eventually become the lead reserve currency, rivaling the greenback, if China is efficient in reforming the economy and especially the financial sector.

A poll of 200 institutional investors conducted by State Street, the world’s second-largest custodian bank, and the Economist Intelligence Unit found that 53 percent of respondents said the yuan may become a major reserve currency.

“We expect yuan depreciation to be moderate and temporary,” JPMorgan’s Zhu said. “The reluctance to see significant yuan depreciation is still deep in the mind of Chinese policymakers, as it may cause large capital outflows, raise political objections from major trading partners and also impede the central bank’s efforts to promote the international use of the yuan.”

He said that JPMorgan maintains its expectation for 1 percent or 2 percent appreciation of the yuan this year, supported by China’s 7.4 percent annual economic growth, a stable current-account surplus at 2 percent and the low likelihood of any full-blown financial crisis.

Credit Agricole and Bank of America Merrill Lynch continue to hold their target of a rate of 6 yuan to the dollar by the end of the year, while Australia & New Zealand Bank said that the yuan may end 2014 at 5.98.

Blip in the yuan signals its strength in the future

No cause for alarm, free-market exchange rates fluctuate. Recent weakness in the yuan is viewed as a natural step in the evolution toward becoming a world reserve currency.

Feng Jianmin

The Year of the Horse started with the exchange rate of the Chinese yuan galloping downhill.

The once seemingly unstoppable appreciation of the yuan began going into reverse on February 18, touching a ten-month low of 6.1808 per US dollar last Friday.

The yuan has lost more than 2 percent against the dollar since January 14, when the yuan hit a 20-year-high of 6.0406.

This reversal goes beyond matters of mere high finance. The declining exchange rate has affected many ordinary consumers, much to their surprise.

An office worker surnamed Chen went for a holiday abroad before the Chinese New Year and spent some dollars while overseas. She waited too long to pay off her credit card bills.

“As usual, I waited for the deadline because later has always been cheaper,” said Chen. “I could have saved about 100 yuan (US$16.31) for every thousand dollars I spent if I had acted sooner.”

But Chen is among many who believe the yuan will rise again.

“Everything needs a rest,” Chen said.

Under control

Financial authorities and economists are interpreting the yuan’s new trend as a sign that everything is under control.

The State Administration of Foreign Exchange called it a “normal” reaction amid recent cash withdrawals from emerging markets and said the possibility for large and continuous outflows of foreign capital is “relatively small.”

The foreign-exchange watchdog said two-way volatility in the yuan is likely to increase as the Chinese market gains strength.

Economists attributed the depreciation to economic data pointing to slower industrial activity, to concerns about financial stability amid quick expansion of trusts and to withdrawal of foreign capital from emerging markets after the US Federal Reserve started paring back its monetary stimulus.

The message Chinese officials want to send is that the depreciation of the yuan is orchestrated and under control.

“We believe the recent yuan depreciation is supported by a shift in policy stance,” said Zhu Haibin, JPMorgan’s chief China economist. “In particular, the central bank would like to revert to a two-way volatility regime and to mitigate the near-term pressure of capital inflows.”

The yuan was one of the best performing currencies in 2013, appreciating by 3 percent against the US dollar — about 7 percent in terms of the real effective exchange rate, or a weighted average exchange rate with major trading partners, according to the investment bank.

The fast appreciation of the yuan in real effective terms placed heavy pressure on exporters and changed market sentiment from 2012, when the yuan barely moved against the US dollar.

Because of fast appreciation and relatively high interest rates, banks in China purchased 2.78 trillion yuan of foreign exchange in 2013, nearly 6 times more than in 2012.

Over the same period, China’s foreign-exchange reserves added another US$500 billion to US$3.82 trillion.

Last November, the People’s Bank of China said that there is “no longer any benefit” from increasing the forex reserves.

Financial risk

Continuous currency inflows could damp the central bank’s efforts to contain credit expansion and rebalance the economy. Excessive US dollar assets are seen as adding to financial risk, and a strong yuan hurts exporters.

By allowing a relatively sharp depreciation, the central bank may be testing new ground in its long-term aim to turn the yuan into an international reserve currency.

“The central bank never really wants too much yuan appreciation,” said Yao Wei, an economist with Societe Generale. “What matters is how it manages the currency.”

Yao said that to make a real difference, the central bank should take bolder reform steps, such as moving from daily to weekly or even monthly settings of the reference rate and widening the band in which the currency is allowed to trade against the dollar.

China currently allows the yuan to trade between 1 percent on either side of central bank’s daily reference rate. Zhu with JPMorgan said he expects the band to double in the next two or three months, when the official rate and trading rate converge and when capital flow is balanced.

Resuming appreciation

Most financial institutions are still predicting that the yuan will resume a stable appreciation this year.

The central bank signaled further currency reforms in four documents it issued in the past two weeks related to the newly formed Shanghai free trade zone.

They outlined operational details, including cross-border yuan lending and fully liberated interest rates for foreign currencies.

Foreign interests are watching closely.

European Central Bank executive board member Yves Mersch said last week that the currency may eventually become the lead reserve currency, rivaling the greenback, if China is efficient in reforming the economy and especially the financial sector.

A poll of 200 institutional investors conducted by State Street, the world’s second-largest custodian bank, and the Economist Intelligence Unit found that 53 percent of respondents said the yuan may become a major reserve currency.

“We expect yuan depreciation to be moderate and temporary,” JPMorgan’s Zhu said. “The reluctance to see significant yuan depreciation is still deep in the mind of Chinese policymakers, as it may cause large capital outflows, raise political objections from major trading partners and also impede the central bank’s efforts to promote the international use of the yuan.”

He said that JPMorgan maintains its expectation for 1 percent or 2 percent appreciation of the yuan this year, supported by China’s 7.4 percent annual economic growth, a stable current-account surplus at 2 percent and the low likelihood of any full-blown financial crisis.

Credit Agricole and Bank of America Merrill Lynch continue to hold their target of a rate of 6 yuan to the dollar by the end of the year, while Australia & New Zealand Bank said that the yuan may end 2014 at 5.98.