Yuan Falls in Hong Kong, Volatility Rises

China is in a currency quandary: How to promote the yuan in global trade while at the same time using it to stabilize market volatility?

The People’s Bank of China is holding the onshore version of the yuan at about 6.2 to the dollar, even as it pledges a bigger role for market forces. In a single statement last week, the cabinet said both that it would allow the currency to move in a wider range and that the exchange rate should be stable.

A freely usable yuan is a key requirement of the International Monetary Fund’s Special Drawing Rights status that China is seeking. Yet loosening controls while stocks are plunging risks the kind of swings that may spur capital outflows and disrupt the world’s second-biggest economy.

“This is a time of policy confusion,” said Cliff Tan, East Asian head of global markets research at Bank of Tokyo-Mitsubishi UFJ in Hong Kong. “The Chinese government is panicking a little bit as they take the equity market selloff as a threat to its credibility. Different departments are coming up with what can be done, but they’re mutually contradictory.”

This tension is being borne out in markets, where the gap between the onshore yuan and the currency’s value in Hong Kong widened last week to 0.29 percent, the most since March. While the onshore rate has remained fixed, the offshore yuan tumbled the most in three months on July 24 as the cabinet’s statement sowed confusion among traders.

Wider Band?

JPMorgan Chase & Co. and Commonwealth Bank of Australia took the State Council’s statement as a sign China will relax the limit of 2 percent moves either side of a daily fixing.

Achieving SDR status would be the crowning achievement of the nation’s efforts to boost global use of its currency and challenge the dominance of the dollar. The yuan failed to make the cut in 2010 because it wasn’t deemed to be freely usable. The next five-yearly review is scheduled for November.

It’s critical for China to adopt a flexible, market-based exchange rate to help correct the imbalances that are limiting domestic consumption, the IMF said in a report.

“Let the exchange rate trade more freely within the band first and then we can talk about widening the band,” said Ken Peng, a strategist at Citigroup Inc. in Hong Kong. “The intervention has been very aggressive in the foreign-exchange market during this equity rout. That’s an easy target for those who are opposed to China joining the SDR.”

Awaiting Direction

Widening the trading band will add unwanted uncertainty at a time when financial markets are already volatile.

A measure of anticipated yuan volatility in three months’ time rose to 1.61 percent on Wednesday, above the 1.4 percent average of the past two months.

The Shanghai Composite tumbled 29 percent from its June 12 peak through Tuesday, the biggest loss among global benchmark indexes, after a 12-month rally that saw it surge 150 percent.

Some of the signs for China’s currency are more positive. Yuan trading in London bucked the global trend of declines in April, climbing to a record $43 billion a day, up 25 percent from October, data from the Bank of England showed this week.

And the PBOC issued new rules this month making it easier for big international investors to access its bond market.

There are dissenting voices, though, spurred by the rout that’s wiped $4 trillion from Chinese equities.

The goals of opening up the capital account, which tracks investment flows, and making the yuan fully convertible should be reassessed given the stock collapse.