1. The PBoC is trying to strike a balance between near-term financial stability and the long-term interests of the economy.
While it is widely acknowledged that a weaker currency bodes well for a country’s inflation outlook and debt mechanism, it could also trigger capital outflows and dent market confidence, which seem to be bigger concerns for Chinese policymakers at the present time.
2. The PBoC is currently focussing more on the stability of the CNY CFETS basket than on US/CNY.
We would expect then the Chinese authorities to continue to stabilise CNY, particularly considering the upcoming Nineteenth National Congress of the Communist Party of China (NCCPC) on October 18.
A better balance between inflows and outflows is a critical consideration for any potential relaxation in the capital account.
To expand our thinking: despite the merit of a weak currency, Chinese authorities are more concerned about CNY depreciation currently, as it may result in further outflows based on previous experience.
The exchange rate was positively related with non-banks’ purchasing of foreign currencies from the second half of 2015 to the first quarter of 2016, before the authorities took concrete administrative actions to constrain the outflows.
Therefore, it is a natural reaction for the officials to reduce fund outflows by stabilising the exchange rate and hence market expectations.
We believe Chinese officials view the outflows as a critical threat, as they deplete China’s FX reserves and invoke unpleasant memories of the Asian Financial Crisis.