The renminbi currency will undoubtedly experience loss force as net capital outflows exceed China’s present consideration surplus. Nevertheless, China will neither fly its currency nor permit a big depreciation.
The US’s monetary system is more vulnerable to US actions by floating a dollar in the world’s economic system, which is currently dominated by the US. China’s technique is the same: to lessen its vulnerabilities to the US- dominated techniques.
The People’s Bank of China, the central bank, should never sell foreign dollar reserves to protect the exchange rate. Such a move would increase regional interest rates and tighten home liquidity.
The last thing China needs is tightening cash for an business that is suffocating from recession. A yuan devaluation, in the form of a quick or one-off exchange rate adjustment, is what the international funding community is expecting, as a result of this set of circumstances.
Under specific circumstances, for a managed, pegged change level program like China’s, a one- off or quick devaluation may be preferred to a slow, steady depreciation.
The idea is that rising expectations for dollar depreciation may cause more capital outflows. These dynamics can be fulfilling and frequently cannot be reversed without significant exchange rate adjustments.  ,
But, Beijing will not resort to a one- off or fast weakening, at least never for today. Given Beijing’s present policy priorities, the cost-benefit analysis of this choice is unpleasant.
Second, the PBoC manufactured a modest 2 % weakening of the yuan in August 2015, which resulted in a decline in share charges, both in China and worldwide. That incident is undoubtedly still fresh in the minds of PBOC policymakers.
Second, a sudden yuan depreciation will ( 1 ) stifle confidence in consumers and private businesses, ( 2 ) exacerbate tensions with the US during a turbulent election year, and ( 3 ) undermine China’s efforts to internationalize the yuan. For Beijing policymakers, these negatives likely outweigh the positives of a currency devaluation.
Finally, Chinese exports are already very competitive, and a small-to-moderate currency weakness wo n’t be much help for them in the near future. 1 ) A weak income or a low propensity to purchase all kinds of goods in foreign markets and 2 ) tariffs that some nations, like the US, have imposed on its products, are constrained by demand for mainland exports.
A preventive and significant devaluation of the yuan would increase the likelihood that other countries, like the EU, will impose significant tariffs on Chinese goods in addition to the US.
Thus, the PBoC will only permit gradual and moderate currency depreciation for the remainder of this year, which is in the ballpark of 5 %. So, would this forecast not support even more capital outflows in anticipation of further currency depreciation? It likely would.
Authorities will likely respond by putting in stricter administrative controls to stop capital outflows, though. In the end, this will render the market players who have so far benefited from capital outflows from the mainland vulnerable.
Critically, mainland residents ‘ investments in gold, other metals and Hong Kong- traded Chinese stocks are forms of capital outflows, all of which weigh against the yuan’s value.
The PBOC regulates all gold imports, allowing it to temporarily stifle the quota for those imported and to compel onshore investors to stop selling gold and gold-linked goods to banks and trading companies in China.
Despite this, we remain confident that the PBOC will continue to diversify its foreign reserves in the face of declining demand. Diversification requires ongoing purchases of gold because there are few alternatives to the greenback or the other currencies of the Western bloc. Therefore, any pullback in gold prices will likely be mild and transitory.
Notably, when monetary authorities buy gold using their own international reserves, this does not represent a capital outflow and does not have an impact on the value of the currency. The basis is that, unlike residents, the central bank uses its US dollars, not local currency, to buy gold.
In addition, the Southbound Stock Connect program has been a source of funding for onshore investors who have invested in Chinese stocks listed in Hong Kong. These stocks are listed in the Hong Kong, which is a parimeter with the US dollar.
These equities are likely to be considered foreign currency assets, protecting them from the yuan’s depreciation.
Yet this perception is misleading. These businesses ‘ assets and revenues are primarily from mainland China. Among them, there are few exporters. The equity prices of mainland Hong Kong companies will drop in Hong Kong dollar terms if the yuan declines.
Therefore, buying Chinese companies ‘ stocks in Hong Kong will not viably shield their assets from potential exchange rate depreciation for mainland investors.
The policy of gradual and marginal changes in the yuan’s value will likely continue despite recent significant capital outflows from the mainland. Nor will Chinese authorities likely resort to a one- off, sudden devaluation.
Instead, Beijing will ease capital account restrictions, putting more and more risk for financial market players who have recently benefited from these outflows.  ,  ,
Arthur Budaghyan is BCA Research’s Chief Strategist, China Investment Strategy and Emerging Markets Strategy. More details about these tactics are available here.