Will the yuan become the world's strongest currency?

The Chinese currency is likely to appreciate against the US dollar at 2 to 3 per cent annually, according to Stratton Street. Photo / 123RF

China's yuan is likely to become one of the world's strongest currencies, even as concerns mount over slowing growth in the world's second largest economy, said Andy Seaman, fund manager and partner at British investment firm Stratton Street.

Seaman said he was bullish on the outlook because of China's current account surplus and large net foreign asset positions, though shifts in the nation's exports should be expected.

China's current account surplus - which measures the net flow of goods, services and investments - was equivalent to 1.9 per cent of gross domestic product in 2016, down from 2.7 per cent in 2015, according to the South China Morning Post.

However the absolute sum is expected to remain sizeable because of the government's support for high-skilled manufacturing, services and increased domestic consumption is likely to increase productivity, Seaman said.

Analysts generally perceive currencies associated with countries that have net foreign asset surpluses as "safe havens", as investors are inclined to bring their foreign assets back home during periods of risk aversion.

"If the currency gradually appreciates along with productivity gains in China, then the current account position can remain relatively stable," Seaman said, adding that the decision by the People's Bank of China, the central bank, to clamp down on excessive credit growth and push up interest rates had improved the attractiveness of the yuan.

The PBOC has guided market interest rates higher using reverse repurchase agreements and its standing lending facility and medium-term lending facility earlier this year, while keeping benchmark interest rates steady in an attempt to stave off capital outflows.

Moreover, the central bank governor, Zhou Xiaochuan, forecast the economy would grow 7 per cent in the second half of this year, accelerating from 6.9 per cent in the first six months mainly because of rising household consumption, according to a statement published on its website on Monday.

The yuan has risen 5.1 per cent against the US dollar to 6.6042 so far this year. Seaman expects China will target modest appreciation of about 2 to 3 per cent a year.

Stratton Street's RMB Bond Fund is up 16 per cent so far this year, partly because of gains from the currency, outperforming 98 per cent of its peers, according to Bloomberg data.
The fund, which invests in Asian debt denominated in US dollars and then hedged into yuan, holds short-dated bonds of CNOOC, Sinopec and China Shipping.

Some analysts however found it was hard to ascertain the true value of China's net foreign surpluses because of its partially closed capital account.

Celeste Tay, senior sovereign analyst at Loomis Sayles, which manages US$257.6 billion ($359.4b) of assets, said

China's net international investment surplus was large but still significantly lower than Japan's.

More importantly, with partial capital controls still in place for the yuan, it does not qualify as a safe haven currency, Tay said.

"The yuan's strength was more about policy changes from the central bank and had less to do with perceptions of the currency as a safe haven," Tay said.

In May, the PBOC introduced a new "countercyclical variable" that signalled that its policy to gradually depreciate the yuan to support economic growth had ended, and which subsequently led to a strong rally in the currency.

Investors are waiting to see that if the ruling Communist Party's congress, which kicks off today, will signal stronger implementation of reforms given the nation's sustained economic growth this year.

Last week, PBOC governor Zhou called for China to accelerate reforms of its exchange rate system and to relax capital controls, although the bank does not have independence in adjusting policy and regulation, which is set by the State Council, China's cabinet.

Zhou told the financial magazine Caijing that China must embrace free trade and investment, let the market decide the yuan's value, and scrap capital account controls.

The three elements were interlinked and could not be separated, he added.

His comments immediately triggered market expectations for an expansion of the currency's daily trading band against the US dollar to 3 per cent from the current 2 per cent.

Relaxation in capital controls has also started to get under way, with the PBOC already making it easier to short the currency. For example, last month, it scrapped the 20 per cent reserve requirement imposed since 2015 on the amount financial institutions have to set aside to buy dollars for clients.

"Until China allows a real two-way free flow of capital, it is difficult to see the yuan as a relative 'safe haven' currency," said Tay of Loomis Sayles.

- South China Morning Post