China faces harsh dilemma as yuan comes under pressure

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Subscribe to enjoy similar stories. China is walking a tightrope on its currency. Economic fundamentals suggest a weaker yuan, but the specter of capital outflows still haunts Beijing, making it wary of any sharp moves in the currency.

The yuan has made a small but symbolic move lately, with Beijing allowing it to slide past the 7.3 level where state-owned banks had often stepped in to support the currency in recent months. At around 7.33 versus the dollar, the yuan is currently also trading close to the weak end of its daily trading band. The currency is allowed to move 2% to either side of a reference rate that is fixed daily by the central bank.

But speculators would be wrong to think that means a sharp depreciation is in the cards. China’s central bank has vowed to keep its currency stable and it has backed that promise with action including draining yuan liquidity in Hong Kong by issuing a record amount of short-term bills. The regulators also made adjustments to rules for cross-border financing, making it easier for Chinese companies to borrow overseas and thus lessening the need to convert yuan into foreign currencies.

There are certainly reasons for the yuan to weaken, especially against the dollar. The economies of the U.S. and China are moving in opposite directions: Bond yields in the U.S.

have surged as the market expects fewer rate cuts from the Federal Reserve and potentially inflationary policies from the Trump administration, while yields in China have hit record lows as its economy struggles to stay out of deflation. U.S. 10-year government bonds now yield around 3.1 percentage points above those of China, compared with around 1.4 percentage points a year ago.