Market forces are mostly to blame for the yuan's unprecedented fall against the dollar in recent months, market participants say, with Chinese regulators now busy propping up the currency, marking a major reversal in approach as the country's economic growth slows.
The yuan has fallen 1.4 percent against the U.S. dollar this year and touched 10-month lows, its first period of extended weakness since China's landmark de-pegging of the currency in July 2005.
In the past, China's trade partners -- the United States in particular -- complained that the Chinese government deliberately undervalued its currency to support exports.
The decline of the yuan this year has led some to suggest that Beijing is deliberately flogging it downward, but the recent behavior of the currency does not support that argument.
Market participants who spoke to Reuters said that enduring weakness in the euro and other non-dollar currencies are mostly to blame for the yuan's recent fall against the dollar. The yuan actually rose 1.3 percent in nominal terms against a broad basket of global currencies in the first six months of 2012.
But most global trade is still settled in dollars, and drastic declines in the dollar/yuan rate could destabilise China's domestic markets, by making imported oil more expensive, for example, encouraging capital outflows and adding to overall economic uncertainty in the world's second-largest economy.
Thus, where China's regulators once worked to cap the yuan's rise, they now appear to be scrambling to hold it up.
"The weakening of the yuan is more than anything a response to market conditions," said Robert Minikin, senior FX strategist at Standard Chartered in Hong Kong.
"(But) it's not wise for authorities to allow a trend of weakening the renminbi to develop. It runs the risk of sparking instability potentially in domestic markets."
LIFTING WITH THE MIDPOINT
To stem excessive depreciation, the PBOC has relied on the official midpoint fixing -- the base rate that the central bank uses to signal the government's intentions toward the yuan's value -- to establish a market floor.
The spot yuan has been allowed to show increased volatility since April, but is still restricted to trading within 1 percent of the fix in either direction.
In a reversal of long-established patterns, spot yuan began to consistently trade weaker than the midpoint in March, indicating that the central bank's guidance is, if anything, serving as a check on market-driven depreciation.
Between July 2005 and the end of the third quarter 2011, a period when economists widely agreed that the yuan was significantly undervalued, the yuan closed weaker than the midpoint only 37 percent of the time, mostly in periods of global economic stress.
Otherwise, the spot rate consistently pushed towards the strong end of the band, with periodic interventions by the central bank the only thing preventing further gains.
But since the fourth quarter last year, the ratio of days the spot prices have traded below the midpoint has increased to 61 percent, including every day since April 9 this year.
Even as the PBOC has adjusted its midpoint in response to rise of the dollar globally, the yuan has strayed gradually farther from the midpoint in recent weeks.
CORPORATE DOLLAR DEMAND
Dollar demand from corporates is also dampening the yuan.
"There is some evidence which suggests that cumulatively in recent years, corporate dollar-selling had run ahead of the amount that was strictly required for trade reasons," said Minikin at Standard Chartered.
"It seems like the corporate sector may have developed an overall short dollar position."
Chinese commercial bank clients bought $3.5 billion more dollars from commercial banks than they sold in June, official data shows, compared to a monthly average surplus of $66 billion in the first five months of the year.
"There has been a shift in clients' mentality. Companies are no longer so eager to trade in their dollars for renminbi," said a trader at a large Chinese bank in Shanghai.
Similarly, foreign interest in yuan-denominated investment products, fueled by expectations of further appreciation, has also shown signs of growing more selective this year.
In the fourth quarter of 2011, as fears of a Chinese hard economic landing intensified, the yuan frequently traded near the weak end of its daily trading band. During that period, clients bought a net $4 billion in dollars a month from commercial banks, an abrupt shift from the $42 billion they offloaded in the first three quarters.
Data on China's foreign exchange reserves also shows that far from buying up the excess, reserves declined by 65 billion yuan in the second quarter to $3.24 trillion by the end of June.
If the central bank were intervening in the market by selling yuan in exchange for dollars, FX reserves would have risen.
Traders have periodically detected signs of central bank dollar selling aimed at boosting the yuan in recent months. Such reports are impossible to confirm, but use of FX reserves to defend the yuan would explain the decline.
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