In recent months, China has taken a different approach to stabilize the yuan compared to its actions in 2015. Back then, the People’s Bank of China (PBOC) resorted to official intervention and burned $1 trillion in reserves to support the currency. However, this time around, as China’s economy faced challenges and capital outflows intensified, the PBOC focused on moral suasion to defend the yuan. Through coordinated actions and market guidance, regulators sought to steer market participants and prevent a destabilizing slide in the currency. While this strategy has successfully stabilized the yuan, it has also had unintended consequences, raising questions about the currency’s prospects as a global reserve currency.
Triage to Prevent a Rapid Depreciation
Eswar Prasad, a professor of international trade policy at Cornell University, describes the PBOC’s approach as a form of “triage” to prevent the yuan from falling too rapidly. By signaling to the markets what kind of selling it would tolerate, the central bank aimed to resist strong downward pressure on the currency. This strategy involved non-standard measures to intervene in foreign exchange markets, mirroring the complexity of domestic and global macroeconomic factors that China currently faces.
As the currency of the world’s second-largest economy and largest exporter, the value of the yuan has far-reaching implications. It determines the price of goods globally and affects trillions of dollars in capital flows. The yuan also serves as a barometer of China’s economic challenges and its efforts to reduce economic reliance on Western powers.
Traders and market participants first noticed significant shifts in the PBOC’s approach in June. The midpoint, which determines the yuan’s trading range for the day, started to deviate from market expectations. This deviation from trader estimates signaled to the markets that the PBOC did not want the currency to align with market pressures. Unlike in 2015, when the central bank made a one-off devaluation, this time the PBOC provided more targeted and specific directions to banks and currency market participants.
State Banks’ Role in Managing the Yuan
State-owned banks played a crucial role in managing the yuan’s value. Whenever there was momentum against the yuan, these banks discreetly became buyers, mainly concentrating their efforts around psychologically significant currency levels. This tactic aimed to contain volatility in the currency. While the size of state banks’ buying remained unknown, their actions seemed to be directed at stabilizing the yuan.
In addition to state banks’ buying, regulators issued “window guidance” to smaller lenders, advising them to reduce dollar holdings. Major state-owned banks also cut dollar deposit rates, encouraging exporters and households to switch dollar receipts into yuan. These measures aimed to align market participants’ behavior with the central bank’s intended direction for the yuan.
To exert further control over the yuan, authorities closely monitored exporters’ foreign exchange buying and selling plans. They increased the frequency of surveys to gain insights into the intentions of exporter customers. These efforts, combined with the moral suasion tactics, drove a significant reduction in yuan trading volumes. In October, the volume of yuan traded onshore reached a record low, showing that the central bank’s actions have chilled the market.
The Unpredictable Path Forward
Although the yuan has stabilized comfortably above its 16-year low in September, market players remain cautious. They are unwilling to directly challenge the PBOC, but they are also hesitant to fully comply with its directives. This cautious approach is reflected in the sentiments of exporters like Zhu, who faces the dilemma of whether to save her dollar payments or convert them back into yuan. The uncertainty surrounding the yuan’s future remains a challenge for market participants and analysts.
China’s changing strategies to stabilize the yuan have diverged from its previous interventions. Through moral suasion and coordinated actions, the PBOC aimed to prevent a rapid depreciation of the currency. While this strategy has successfully prevented a destabilizing slide, it has also had unintended consequences, such as reduced trading volumes and concerns about the yuan’s future as a global reserve currency. As China faces complex domestic and global economic challenges, the path ahead for the yuan remains uncertain, leaving market participants and analysts cautious about its future trajectory.
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