China is cheapening the yuan for scarier reasons than usual

China is cheapening the yuan for scarier reasons than usual

By Gwynn Guilford @sinoceros May 9, 2014

The sharp drop in the yuan’s value that started in mid-February 2014 has riled up US government officials who suspect that the People’s Bank of China is helping Chinese exporters at the expense of everyone else. But it has remained a bit of a mystery who was actually behind that drop—the PBoC or traders.

Until now, that is. New clues out from the PBoC show that it had been cheapening the currency all along. The big news, however, isn’t that the PBoC is up to its old tricks again. More worrying are new hints that a big rationale behind the move is deflation setting in throughout China.

First, a little background on the PBoC’s yuan-management habits. To maintain its desired yuan value, the PBoC buys foreign currencies from Chinese exporters and foreign investors, likely offering more yuan per $1 than the market would. Since 2005, this practice has allowed the yuan’s value to rise nearly 30%. Then on February 17, the yuan reversed its steady climb, followed by a still bigger drop in March.


Some have blamed currency speculators for the yuan’s dive (more on that here). But new data shows the PBoC paid 174 billion yuan ($28 billion) for foreign currencies in March, more than nine-tenths of all foreign exchange purchases in China that month.

​​ Here’s where things get weird though. When the PBoC buys dollars from exporters—and gives them more yuan than the market rate—it pumps extra yuan into the Chinese economy. Since that surge of cash could cause prices to rise perilously fast, the PBoC normally “sterilizes” its FX purchases, issuing yuan bonds to absorb the extra liquidity sloshing around the system.

Not in March, though, reports China Real Time. Economists think the PBoC’s declining to sterilize might be because extra money in the system pushes down interest rates—something China could use right about now, given that it’s hovering on the brink of deflation:


Now normally, falling prices suggest that that companies and households are paying down debt. That’s not what’s happening in China, though, says Wei Yao, Société Générale economist. Credit is still growing at twice the pace of GDP—meaning some pretty aggressive borrowing is still going on. That investment should be flowing into the economy, driving up prices. So why isn’t it?

Probably, says Yao, because it’s the state sector that’s still borrowing like crazy, investing in projects that don’t make money.

​ So what’s the PBoC to do? Some economists recommend the normal cure for this ill: cut rates and encourage lending. SocGen’s Yao, however, is skeptical. Not only will “opening the credit tap will still favor the less-efficient state sector,” she says, but if China is to implement its promised financial reforms, it will need highish rates to prevent a lending binge that typically happens when government-coddled banks suddenly have to compete for business (this proved catastrophic in Japan, for instance).

It’s good, then, that the PBOC is not directly loosening rates. Its yuan-cheapening, however, is risky, says Yao, since it could drive capital out of China. And that sucking-up of money supply would be disastrous for a economy that lives on liquidity.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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