FXStreet (Mumbai) – The Chinese economy did not have a great start to 2016. The latest PMI figures have been dismal. The Caixin manufacturing PMI fell in December to 48.2, down from 48.6 registered in November, contracting for a tenth month. Caixin data released today showed activity in the services sector expanded at its slowest rate in 17 months in December. The Caixin/Markit services PMI fell to 50.2 in December from 51.2 in November. The latest data dimmed hopes that policy makers’ attempt to restructure the economy with more emphasis on services and consumption will offset the drag from weakness in the manufacturing sector.
That was not all. China’s woes continued when on the very first trading day of 2016, a 7 per cent selloff in the CSI 300 Index caused stock trading to be suspended in China. The PBoC’s damage control initiative which comprised injecting 130 billion yuan ($19.9 billion) into financial system failed to soothe jittery investors. Chinese stocks yesterday ended down 0.3 per cent. The initial rebound seen post the central bank’s decision to increase capital in the system was short lived as investors continued to suspect Beijing’s further easing intentions.
Yuan lowered
The PBoC, amidst the grim economic scenario, devalued the yuan. The central bank set the midpoint rate at 6.5169 per dollar, which is weaker than the previous 6.5032 and also the weakest level since April 2011.
A Shanghai trader said “State-owned banks were offering dollar liquidity around 6.52 per dollar”. He felt these banks were “trading on behalf of the PBOC to help control the pace of yuan depreciation.” The intervention by the central bank is unlikely to have large impacts as traders are likely to continue ‘shorting’ the yuan as China’s economic fundamentals continue to remain a worrying factor.
The Chinese yuan plunged to a five-year low in offshore trading today. The offshore yuan fell to 6.6915 against the greenback, which is the lowest rate of exchange noted since the last quarter of 2010. The offshore yuan marked a 2.1 per cent discount to 6.5506 level of the onshore yuan. Yesterday as well the yuan was noted to have strengthened in the onshore spot market, trading at 6.52 per dollar at 0830 GMT in Shanghai. The gap between onshore and offshore yuan has further widened today.
Angus Nicholson, a market strategist at IG observed “The spread between the onshore and offshore yuan has now reached some of the highest levels in the pair’s history – a clear indication of both volatility and intervention”.
Further devaluation of the yuan possible
The difference has heightened expectations of further devaluation of the yuan. Markets now feel that the yuan will continue to depreciate against the on account of sluggish growth prospects, increased capital outflows as well as demand for overseas assets. HSBC analysts also feel there remains strong possibility that “there could be stronger dollar demand against the yuan as the latter’s depreciation expectations remain entrenched.”
The central bank had intervened in the currency market yesterday to halt sharp decline. The PBoc’s decision to buy yuan in the secondary market and follow it with lowering the value of the currency, has led analysts to believe that these measures adopted by the central bank are in tune with its plan to let the currency reflect market forces. Maybank analysts explained the situation. They said “To achieve a more market-balanced yuan, the PBOC has to ensure an orderly depreciation before they can see an eventual appreciation in the currency”.
Promoting a sustained weakness in currency will cost the economy its capital. The weakness in yuan is likely to increase capital outflows causing liquidity crunch in the system. Also, this constant intervention in markets will also raise questions on how serious China is to execute market reforms. Nomura analysts have warned “Depreciation could result in a global market sell-off that ranges from Asia FX to broad equity market weakness”.
Analysts also fear that the central bank intervention will lead to slower pace of fall in onshore yuan, which in turn will hinder the central target of a free currency.
(Market News Provided by FXstreet)