(Correction to remove citation in paragraph 6 following post-publication review)
SHANGHAI (Reuters) – Chinese businesses are hoarding dollars because they fear their currency will weaken, which in turn is exacerbating the yuan’s decline, caused by unstable stock markets and weak growth in the world’s second-largest economy.
This vicious cycle has been underway for months in the continent’s currency markets, spurred by the rising dollar yield. Foreign currency deposits rose by $53.7 billion from September to $832.6 billion, data from the People’s Bank of China (PBOC) shows.
Analysts say two things need to happen to end the downward spiral: the Federal Reserve needs to make deep rate cuts or the yuan needs to hit some form of bottom. Both seem distant.
is at five-month lows and has lost 1.9% against the dollar this year as foreign investors withdraw more money from its struggling markets. The currency has fallen from around 6.7 per dollar in early 2023 to around 7.24 now, a decline of 5%.
Regular inflows from domestic exporters have dried up, as companies choose to park their dollars offshore in deposits that earn them 6%, compared to 1.5% on yuan deposits at home, and just wait for rates of better gearboxes.
“The rate differential between the US and China is the most positive since 2007, and I think this important fundamental fact is enough to explain why Chinese exporters are reluctant to exchange dollars for yuan,” said Alvin Tan, head of Asia strategy FX at RBC Capital. Markets. “This huge positive yield spread isn’t going away anytime soon.”
Even for businesses that choose to take their dollars home, while authorities have capped dollar deposit rates at major lenders at 2.8% since the middle of last year, there are other management products dollar-based assets that invest in foreign funds offering as much as 4.4% for 7-day investments.
Becky Liu, head of China macro strategy at Standard Chartered (OTC:), says a “confirmation of the Fed’s rate cut, including a clearer dollar weakening trend” could be a catalyst for companies to convert their FX foreign currencies in yuan.
However, considering the recent run of robust economic and inflation data in the US, the Fed’s rate cuts will be delayed until the end of 2024 and the dollar is in crisis.
This means the yuan is more likely to reach 7.3, the level at which exporters could bring dollars home, while the authorities could protect it at that level. It was roughly the bottom for the yuan in both October 2022 and July 2023.
Several investment banks also expect the yuan to weaken to 7.3 per dollar by the third quarter of this year, but not beyond. A Shanghai-based corporate banker said some of his clients are now targeting 7.3 as the level to sell their dollars.
TERMS OF TRADE
The Chinese authorities do not seem particularly troubled by this accumulation of dollars by businesses and citizens. State banks that normally act on behalf of the People’s Bank of China (PBOC) have been buying the yuan to stem its fall.
The PBOC did not respond to a Reuters request for comment.
Barclays strategist Lemon Zhang says “exporters’ reluctance to convert their currency revenue is likely to continue for the next two quarters.”
He doesn’t expect Chinese regulators to force exporters to settle their foreign currency earnings, but says there could instead be smaller macroprudential or tax relief measures to encourage conversion.
Despite the decline, the yuan has not fallen as fast as the currencies of some of its trading partners, notably Japan, whose yen has fallen 9% this year, which has eroded China’s trade competitiveness and dented China’s its trade surplus.
In 2023, China’s trade surplus fell 11% to $593.9 billion from the previous year.
Analysts at China Construction Bank (OTC) estimate that the foreign exchange clearance rate, which measures the conversion of export earnings into yuan, was just 51% in February as corporate clients deposited dollars.