They Don't Have Enough Reserves: PBoC Intervenes to Defend Yuan

Bloomberg: PBOC’s Presence Seen to Prevent Yuan From Deeper Plunge
China is unlikely to let the plunge in the yuan get out of control, according to Macquarie Securities Ltd.

The People’s Bank of China will want to keep the currency stronger than 7 per dollar -- a level not reached since the financial crisis -- as a break past that may lead to a "vicious cycle" of capital outflows and sharper depreciation, said Larry Hu, head of Chinese economics at Macquarie.

The central bank can stabilize the exchange rate by setting strong fixings and selling the dollar directly in the spot market, he said. "Also, China doesn’t want the currency to be too weak as that will make negotiations with the U.S. tougher."
I suspect an attack on the yuan won't begin until after reserves suffer a meaningful decline. At this point, that might be $30 to $50 billion yuan, enough to signal the capital controls have failed or that defending the yuan is getting expensive. A collapse in the yuan isn't inevitable, but it's getting a heck of a lot more likely if this cyclical downturn doesn't stop soon. USDCNY is very close to 7.0, DXY is within striking distance of 100 and an escalating trade war will start curbing dollar flows into China this summer. The risk of a "multi-sigma" event is increasing, with the possibility for follow on events such as Hong Kong abandoning the dollar peg.

iFeng: 央行离岸出手稳汇率!又在香港布局大动作,吊打空头
Central bank moves offshore to stabilize exchange rate! In Hong Kong, they also made big moves to play short positions
The central bank is stabilizing the exchange rate offshore again!

On May 15, the central bank issued a message that it successfully issued two issues of RMB central bank bills in Hong Kong on the same day, of which three-month and one-year central bank bills each amounted to 10 billion yuan, with bid-winning interest rates of 3.00% and 3.10% respectively. The total bidding volume for this issue exceeded 100 billion yuan, with the main subscribers including commercial banks, funds, investment banks, central banks, international financial organizations and other offshore market investors.

The news seems bland, but considering the special timing of the central bank's issuance of central votes in Hong Kong, its policy intention is well established. Since issuing central bills in Hong Kong can recover the liquidity of offshore RMB, raise the interest rate in the offshore market and raise the cost of shorting RMB, thus achieving the goal of stabilizing the exchange rate. Combined with the rapidly rising market changes in the expectation of RMB devaluation in recent days, it can be seen that the central bank has obviously intended to stabilize the exchange rate by issuing central bank votes at this time.

In fact, except that the offshore RMB exchange rate suffered a heavy blow on Monday, with a drop of 600 basis points during the day, the RMB exchange rate both yesterday and today has a trend of correction. Some analysis points out that there is no lack of central bank stabilizing the exchange rate behind this. As of 13:15 on May 15, the onshore RMB exchange rate was 6.8761, with a devaluation of only 93 basis points. The offshore RMB exchange rate was 6.9053, up 9 basis points from yesterday.

Many analysts pointed out that the probability of RMB exchange rate falling below 7 in the short term is not very high until there is no further negative news about Sino-US trade friction. More importantly, the current trend of RMB exchange rate is event-driven and multi-empty. For enterprises and individuals, instead of blindly betting on unilateral appreciation or devaluation, it is better to stick to the concept of financial neutrality and manage exchange rate risks through hedging tools, otherwise they will be easily beaten.
China can intervene in Hong Kong to prop up CNH, but it costs money:
"CNH usually better reflects the market's expectation of RMB exchange rate than CNY, but the central bank has strong control over the offshore market. In the past, people usually observed some operations (such as forward foreign exchange purchase, foreign exchange swap, etc.) of the branches of major Chinese banks in Hong Kong in the offshore market to fathom the policy intentions of the monetary authorities behind them. " A Hong Kong foreign exchange trader told a Chinese reporter from a securities firm, but if the central bank issues central bank tickets in Hong Kong, it is equivalent to directly facing the participants in the offshore market and openly communicating its own policy stance. In fact, it increases policy transparency, strengthens communication with the market and is conducive to stabilizing market expectations.
CNH is the real exchange rate and everyone in China and outside of China knows it. If the PBoC tries to set a high fixing, speculators can force them to spend mightily to defend it.
Undeniably, the trigger factor for this round of sharp decline of RMB is the Sino-US trade dispute, but the real trigger for the sharp devaluation of the exchange rate for many consecutive days is short selling by overseas institutions.

Senior foreign exchange expert Han Renyu told Chinese reporters at the securities firm that the driving factor for the recent rapid devaluation of the exchange rate is not the market supply and demand (i.e. the customers dominated by enterprises and residents), but speculation (mainly the transactions of financial institutions). The dollar soared ahead in the offshore market and followed closely in the onshore market, which usually means that institutional speculation is likely to be the main factor in the devaluation.
Speculative attacks can go on for months. Flashback to 2012: PBOC can't buy a buck; talk of depleted reserves is not alarmist
[Tan Yaling] says there was a recent article stating that if the only way China can stimulate the economy is through investment, then China's $3 trillion in foreign exchange reserves will be exhausted within 5 years.

She says speculation is the greatest threat to China's development and this speculation could exhaust China's reserves. Although China has $3.2 trillion in reserves, it isn't enough to protect it from hot money, not when the global forex market trades $5-6 trillion each day. If there is no long-term strategy to defend the reserves, they could be rapidly exhausted.
Below I will post the Sogou translation of the full article. Back to the iFeng article, it paints an air of calm in the foreign exchange market:
"The direct consequence of the soaring offshore dollar is to widen the foreign exchange gap between China and overseas. There is no doubt that a space of several hundred basis points will excite cross-border arbitrageurs, and the result of arbitrage is that the onshore dollar will definitely soar rapidly. This is not the first time that such a situation has occurred. Generally, there is room for cross-border arbitrage if the domestic foreign exchange difference is more than 100 basis points. " Han Hui said.

However, since this Tuesday, the exchange rate has started to recover, which may include the central bank stabilizing the exchange rate and "beating" bears. There are two interesting phenomena that are meaningful: on the one hand, the central parity rate of RMB against the U.S. dollar was 6.8365 on Tuesday, down 411 points, significantly lower than the closing price of 6.8721 on Monday, which indicates that the counter-cyclical factors in the central parity pricing mechanism may have played a role; On the other hand, on Tuesday, the offshore RMB exchange rate against the U.S. dollar had a strong short-term rise of 150 points, once recovering the 6.90 mark.

The special timing of the central bank's issuance of central bank votes in Hong Kong on Wednesday is a manifestation of the policy intention of stabilizing the exchange rate.

So, does the central bank's move to stabilize the exchange rate at this time mean that the RMB will be protected at "7"? Some analysts pointed out that the central bank's choice of when to stabilize the exchange rate has nothing to do with the specific position of the exchange rate. The key is to observe the settlement and sale of foreign exchange in the market.

"The exchange rate is never the most important point. The monetary authority first considers the pressure of capital flow. If the macro-prudential management of cross-border capital flow is effective and the deficit in foreign exchange settlement and sale is not large, it does not matter whether it breaks 7." South Korea stationed said that if there is another serious imbalance in the foreign exchange settlement and sale market, the invisible hand will act. Even if the RMB reaches around 7 against the US dollar, if the foreign exchange settlement and sale market is calm, then the 7 break will be broken, which is not a big deal. However, if the exchange rate has just reached 6.95 and there is a tide of buying foreign exchange, then basically don't expect to break 7.
Defending the yuan from USDCNY 7.00 is a really loud signal that says otherwise.
Therefore, from the perspective of stabilizing the expectation of RMB exchange rate, many analysts pointed out that there is no possibility of a sharp devaluation of RMB. UBS China Adjusts Exchange Rate Forecast of RMB to USD to 7 at End 2019. Wang Tao, chief economist of UBS China, said that this was mainly because the government might allow the RMB to depreciate slightly in view of the worsening current account balance and the greater downward market pressure on the exchange rate. If the United States imposes a 25% tariff on all Chinese exports, the pressure of RMB devaluation will increase dramatically.

"Nevertheless, the central bank may still try its best to avoid a sharp devaluation of the exchange rate, so it is expected that the RMB exchange rate against the US dollar will only moderate to 7.2 in 2019. If the tariff increases continue to take effect, the RMB exchange rate may further depreciate in 2020. " Wang Tao said.

Yu Yongding, a member of the Faculty of Social Sciences, also told the Chinese reporter of the securities firm that as Yi Gang, governor of the Central Bank, said earlier, we will never use the exchange rate for the purpose of competition, nor will we use the exchange rate to increase China's exports, or to consider trade friction tools. We can promise that we will never do this. As for how the exchange rate will change, it is determined by the relationship between market supply and demand. The exchange rate must be flexible.
I agree 100 percent with Yu Yongding. China will not devalue for competitive reasons. It will devalue because it will exhaust its reserves, because it will be unable to contain capital flight or stop an unfolding deflationary credit crisis without massively increasing domestic credit supply, which in turn necessitates inflating the yuan far beyond the constraints of the current exchange rate. As is often said about gold, China has more than enough dollars to fund its economy. The problem is the price of those dollars is set too low.

Sogou translation of Tan Yaling 2012 article: It is not alarmist talk to say that foreign exchange will run out
High-level viewpoint

Tan Yaling, President of China Foreign Exchange Investment Research Institute

Not long ago, an article pointed out that China's foreign exchange reserves of over 3 trillion US dollars could not provide shelter for China's economy. In the future, if China can only continue to promote investment and has no other way to maintain economic growth, China's foreign exchange reserves will be exhausted within five years. This advice deserves attention.

First of all, this "alarmist talk" has sounded the alarm bell for the current stability of China's economy. At present, speculative arbitrage is very serious in our country's market. This speculative state is not only not conducive to development, but will consume the accumulation in the past, waste reserve resources, and make it possible for China's foreign exchange reserves to shrink and run out. Because the market is highly concentrated in speculative arbitrage rather than in the development of entities and industries, coupled with regulatory deficiencies, hot money has provided a space for speculation and a platform for building momentum. As a result, this kind of speculative arbitrage is used by hot money, making hard-won foreign exchange reserves consumed by their own blind obedience.

Therefore, although our foreign exchange reserves are strong, they are not large enough to withstand international hedging risks. At present, we have 3.2 trillion US dollars in foreign exchange reserves, while the international foreign exchange market trades 5-6 trillion US dollars a day. Our scale cannot stop speculative speculation of hot money. Without its own development strategy, risk discrimination and comprehensive and long-term strategic planning, foreign exchange reserves will soon be spent, destroyed and eventually exhausted.

Secondly, the strategy of collecting money from the people is still struggling. The topic of foreign exchange reserves in China has been going on for more than 10 years, but so far the focus is still at the origin: there are too many foreign exchange reserves and the efficiency is insufficient. Although China has the largest foreign exchange reserves in the world, it is a smaller foreign exchange market in the world, and even the foreign exchange market has not been fully opened.

At present, China's financial reform and development are at an important juncture. On the one hand, we have huge foreign exchange reserves, and the symbol of national wealth has attracted the attention of the world and the pursuit of speculators. On the other hand, China's central bank's hedging costs have increased, and the fear of shrinking the price and value of foreign exchange assets is increasing. Refusal or reduction of US dollar assets has become a trend and trend. Such too short-term and simple cognition and demand from the private sector and society will directly affect the implementation and process of China's strategy of collecting foreign exchange from the people. Under the background of the unprecedented financial crisis, this way of thinking is the greatest resistance to the loss of our strategy of hiding money from the people.

It can be seen that this kind of "alarmist talk" actually warns us that the problem of China's foreign exchange reserves is manifested in three aspects: first, it pays more attention to quantity than efficiency; Second, there are too many short-term prices and not enough long-term systems. Third, there are too many short-term countermeasures and the actual effect is not good. As a result, the huge foreign exchange reserves have become a simple burden and burden for our country and have not fully played their role in promoting our reform, construction and development. Therefore, we should refer to the countermeasures we have already taken to reduce market investment and prevent hot money intrusion in response to our reform and development needs through capital injection, investment and special financial policy tools. At the same time, we can consider the convergence mechanism between foreign exchange and RMB, break the passive situation of being restrained by dogmatism of foreign exchange reserves, and solve our own economic and financial problems flexibly and effectively.

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