Pressure Brewing for China in Dollar Scarcity

Nov. 6 – Resurgent expectations of yuan appreciation have made dollars more scarce in China’s foreign exchange market, tripling six-month dollar funding costs and creating new complications for Beijing’s stable RMB policy.

The Economic Times reports that over the past two months, Chinese banks have become eager to sell extra dollars to the central bank, fearing the U.S. currency could fall in value, while their corporate clients are increasingly keen to borrow dollars to buy RMB. This was used to speculate on RMB appreciation or for arbitrage. With expectations of RMB strength unlikely to die down, Chinese dollar funding costs are set to keep rising in coming months and could climb prohibitively high, jeopardizing banks’ foreign exchange business as well as corporate dollar funding for purposes such as trade and investment, dealers said.

The situation is likely to worsen in coming months as banks don’t want to retain dollars and some of their clients are borrowing dollars to conduct arbitrage trading. The People’s Bank of China has kept the RMB at a virtual peg against the dollar since July 2008, confined to a range of only 100 points, partly to help insulate China’s exports from the turmoil of the global financial crisis.

Confounding market expectations, the central bank has shown no signs that it will soon abandon that policy and revert to the steady appreciation seen from July 2005 to July 2008. But with the worst of the crisis now over, and China’s economy recovering faster than its major trader partners, Western policymakers have renewed calls for Beijing to allow the currency to appreciate to help address trade imbalances.

The various pressures for RMB appreciation have generated volatility and uncertainty in the market, and the rise in dollar funding costs in China’s currency exchange market is increasing that pressure.

“Dollar funding costs have become the latest victim of RMB appreciation expectations,” a European bank dealer trading on the China Foreign Exchange Trade System (CFETS) was quoted as saying. “Rises in these costs could in turn become another source of pressure for China to eventually permit its currency to resume appreciating.”