SHANGHAI/BEIJING: China's central bank has taken a hands-off approach to the yuan in the last six months, possibly setting the currency up to depreciate again next year.
Regulators may allow market forces to guide the yuan lower in the first quarter of 2015 to keep it competitive as other Asian currencies slide versus the greenback on expectations the US Federal Reserve will begin tightening policy next year.
The People's Bank of China (PBOC) has phased out daily operations in the market since May, after it engineered a 3.4 percent depreciation of the yuan early this year to deter speculators betting on non-stop gains.
That depreciation dampened investor interest in the Chinese currency - previously seen as a one-way bet - and pushed companies to keep more dollars.
Thus the central bank has some leeway to reduce trading intervention, traders say.
A 10-percent rally in the US Dollar Index in the second half of this year, followed by broad drops in Asian currencies - led by the Japanese yen on the back of the Bank of Japan's expanded stimulus drive last month - have made the yuan even less attractive.
For now, it is being supported by China's strong trade surpluses and is expected to remain firm for the rest of this year as exports are robust through the Christmas season.
But that is likely to change early next year.
"China typically recorded some months of trade deficits in the first quarter in recent years," said Huang Yi, head of forex trading at Guangfa Bank in Shanghai. "Less dollar supply in the domestic market next quarter, plus the global backdrop, will exert downward pressure on yuan if the PBOC stays on the sidelines," he said.
PBOC SITS IDLE
The central bank has tolerated a 2 percent rebound in the yuan since May amid strong trade surpluses, traders say.
At the same time, the growth of the PBOC's forex assets has ground to a virtual halt, with decreases in June, July and September, central bank data shows.
That means it has largely stopped trying to influence the yuan's value in the market, leaving dollar supply and demand to play the key role in determining the exchange rate, traders say.
Meanwhile, Chinese banks have only settled small amounts of forex income - essentially swapping dollars for yuan - despite the record trade surpluses bringing in a massive wave of dollars, data from China's forex regulator shows.
"Chinese firms increasingly tend to keep dollars as assets, balancing that with more yuan liabilities," said a senior dealer at a Chinese state-owned bank in Shanghai.
"The PBOC would be more than happy to see the trend as it has long hoped the yuan could move in either direction, easing the pressure for it to intervene to help decide its value."
At the start of 2014, the market widely expected that the yuan would appreciate another 3 percent like it did last year.
After months of gains in the yuan, the PBOC will be more than willing to see the currency stage another round of depreciation, so much the better if it is at the hands of global forex movements rather than its own intervention, traders say.
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