HONG KONG: China's yuan fell to its lowest level against the dollar in more than two years on Friday, raising questions about whether the world's second-largest economy will devalue its currency to avert a sharper economic slowdown.
Central banks around the world are easing policy to support growth and prevent deflationary pressures from building up. With fears of a global currency war rising, all eyes in Asia are focused on what China will do as it grapples with inflation falling to 5-year lows and aggressive easing elsewhere.
On Friday, the People's Bank of China (PBOC) weakened the midpoint by nearly 100 pips to reflect strength in the global dollar index. The change was the biggest since last March when the central bank engineered a sharp drop in the currency to punish speculators.
The People's Bank of China set the midpoint rate at 6.1475 per dollar prior to market open, weaker than the previous fix of 6.1379.
The spot market opened at 6.2595 per dollar and was changing hands at 6.2698 near midday, 109 pips weaker than the previous close and 1.99 percent weaker than the midpoint. It was the lowest level since October 2012.
The spot rate is currently allowed to trade with a range 2 percent above or below the official fixing on any given day.
The yuan has been trading near the weaker end of the daily trading band in the holiday-shortened week after the Lunar New Year holiday and is on its way to end the month down about 0.3 percent, its fourth consecutive monthly loss.
"Demand to buy dollars is strong as companies need dollars to buy oil and travelling also increases the need for dollars during the holidays," said a trader at a Chinese bank in Shanghai.
Strengthening US economic fundamentals are also exerting pressure on the yuan.
The dollar rose to a one-month high against a basket of currencies on Thursday as data on US inflation and business orders revived confidence in the world's biggest economy and supported bets the Federal Reserve will raise interest rates in the middle of the year.
Traders say the yuan's future moves will largely depend on the dollar's performance, but the lowest level the Chinese authorities will likely accept is probably 6.4 per dollar, or a depreciation of 3 percent for the year.
In the offshore market, the yuan was trading 0.21 percent weaker than the onshore spot rate at 6.2832 per dollar.
Offshore one-year non-deliverable forwards contracts (NDFs), considered the best available proxy for forward-looking market expectations of the yuan's value, traded at 6.4, or 3.95 percent weaker than the midpoint.
"Arbitrage between onshore and offshore yuan markets is prevalent and the onshore yuan is dragged down by its offshore peer as investors there continue to short the yuan," said the trader in Shanghai.
"However, the central bank's attitude is quite clear that it allows yuan to fall, but whenever the yuan is close to the trading band, it will jump in to sell dollars," the trader said.
One-year NDFs are settled against the midpoint, not the spot rate, and now that the trading band has been widened to 2 percent in either direction, corporates are much warier of using the NDF to hedge given the basis risk inherent in them.
As a result the market has lost liquidity in recent years and has frequently proven an unreliable measure of market sentiment.
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