Yuan sees increased volatility as depreciation pressure mounts

The Chinese currency has seen sharp volatility against the U.S. dollar this week as a strengthening dollar stokes worries of the yuan's depreciation.

The yuan continued to decline against the dollar on Wednesday with its spot exchange rate closing at 6.2480 per U.S. dollar, down 45 basis points from Tuesday, according to data released by the China Foreign Exchange Trade System.

The rate also dropped almost 1.95 percent from the central parity rate, just short of the two-percent floatation band allowed by authorities.

On Monday, the Chinese currency sank to its lowest level in seven months by closing at 6.2542 before rebounding to 6.2435 on Tuesday.

Economists believe the Chinese currency's volatility is caused by normal fluctuations, which have been triggered by quantitative easing measures by the European Central Bank and interest rate cuts in markets such as Switzerland, Denmark, Egypt, India, Turkey and Canada.

"Some central banks are successively cutting rates to cope with rising deflation risks and lift economic momentum. These measures and particularly the ECB's bond-buying program were the direct cause of the yuan's slump," said Wen Bin, chief researcher at China Minsheng Bank.

DEPRECIATION PRESSURE MOUNTS

The dollar started an upward trend in July last year against sharp falls by other major currencies, including the euro. The U.S. Dollar Index has gained nearly 18 percent since then.

Analysts said the trend weighs negatively on the yuan's rate against the dollar, especially when a looming interest rate hike by the U.S. Federal Reserve has led to expectations of a stronger dollar.

Taking into account an economic slowdown in China, Wen predicted the yuan, also known as the RMB, will likely depreciate by as much as 3 percent against the dollar within the year, reaching around 6.4 per dollar.

"The yuan will very likely depreciate against the dollar, but this will happen in a limited zone," said Ding Zhijie, a professor at the University of International Business and Economics. Ding also predicted the yuan to trade below 6.4 against the dollar within the year.

Prior to the recent depreciation, the Chinese currency had consistently risen against the dollar since China started a major foreign exchange reform on July 21, 2005 by scrapping a peg against the dollar. Since then, the yuan has climbed more than 32 percent against the dollar.

However, the Chinese currency has seen regular two-way movements since February after hitting a historical high of 6.04 in mid-January last year. The central parity of the yuan fell 0.36 percent against the dollar in 2014.

VIEWS ON THE YUAN'S DECLINE

"It is not surprising to see the yuan fall against the dollar given the currency's cumulative appreciation over the past eight years," said Yu Xuejun, an official at the China Banking Regulatory Commission.

"If the yuan stays firm as it has in past years, it will bring more harm than benefits to the Chinese economy because exports will be less competitive, which will further hamper employment and economic recovery," Yu said.

Analysts caution that while the yuan has recently fallen against the dollar, it has essentially appreciated against other currencies such as the euro and Japanese yen as their depreciation against the dollar has been much steeper.

Yao Jingyuan, former chief economist of the National Bureau of Statistics, predicted that the yuan's exchange rate would be generally stable this year rather than undergoing drastic ups and downs.

Wang Bin said that as the central bank gradually eases foreign exchange interventions, the yuan's exchange rate will be influenced more strongly by market factors and reach an equilibrium.

Analysts also said that China's efforts to promote the yuan's globalization mean authorities will maintain the currency's stability.

Under China's exchange rate reforms, including allowing greater volatility for the yuan by raising floatation bands and conducting currency swaps with other central banks, the yuan became one of the five most widely used currencies in global payments in December behind the dollar, the euro, the British pound and Japanese yen, a report revealed on Wednesday.

Deputy governor of China's central bank Pan Gongsheng said last Friday that China will continue to improve the RMB exchange rate mechanism this year in line with the central leadership's financial reform drive.

"We will continue to allow the yuan's greater volatility this year by allowing the market to play a more decisive role," Pan said.

Economists also warn of the impact on industries amid the yuan's volatility, with exporters likely to benefit. Meanwhile, airline companies, which have heavy dollar debts, and the real estate market with its exposure to speculative capital investment are likely to suffer the brunt of the yuan's fall and divestment.