China's yuan fell sharply against the dollar in the offshore forwards market on Tuesday after a senior Chinese planning official was quoted as saying the currency could drop because of the Chinese economy's weakness. But many dealers said the yuan had little potential to fall further in the foreseeable future.
They noted that China had repeatedly indicated it wanted to keep its currency stable during the global financial crisis, because any weakness could prompt capital outflows. "The market is likely to react less sensitively this time to the possibility of yuan depreciation, compared to a similar incident last December," said a dealer at a US bank in Shanghai.
The yuan will soon stabilise and resume trading narrowly unless the Chinese central bank sets an expectedly weak mid-point at the start of trade on Wednesday, the dealer added. Asked in an interview with China Briefing magazine whether there would be any change in the yuan, which the Chinese central bank has kept stable since mid-2008, Zhang Xiaoqiang, deputy head of the National Development and Reform Commission, said:
"During Wen Jiabao's trip last month to Europe, we found that the RMB has reached a sustainable and fair level. The currency is not facing any pressure to be stronger. "However, our economy this year is weakening, and unemployment is rising. The RMB could weaken to a position of around 6.95 to 7 against the US dollar."
The Chinese central bank has used its control of market mechanisms and indirect intervention when necessary to keep spot yuan in a range of about 6.81-6.88 since last July. One-year dollar/yuan non-deliverable forwards jumped as high as 7.0100 bid after news of Zhang's comments hit the market, from 6.9500 previously and 6.9350 at Monday's close.
Their high implied yuan depreciation of 2.49 percent over the next 12 months from the day's spot mid-point, against depreciation of 1.45 percent implied at the close on Monday. One-year volatilities, which reflect demand to hedge against a major exchange rate move, jumped to a ten-day high of 10.00 percent bid from 8.50 percent previously and Monday's close of 8.25 percent. However, they pulled back to 9.25 percent late on Tuesday.
Many traders in Shanghai said they did not believe Zhang's remarks indicated any change in government policy. The Chinese central bank appeared to conduct a similar test of the market in early December, when for the first time it allowed the yuan to drop to the bottom of its permitted daily trading band against the dollar.
After several days of such tests, the central bank resumed keeping the yuan very stable. Traders speculated it may have wanted to signal to Washington that letting the yuan move freely, as US officials have demanded, could be counterproductive by weakening the Chinese currency instead of strengthening it. Spot yuan fell moderately against the dollar to a low of 6.8439 on Tuesday after Zhang's remarks, from around 6.8360 previously and Monday's finish of 6.8340. But the yuan then partially recovered to close at 6.8395.