Chinese Move To Liberate Yuan Creating Turbulence

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China’s economy has been taking numerous hits over the last few months. Weak economic indicators, a growing debt problem, and rocky financial markets top the long list of mounting challenges. Now, the Chinese government’s move to liberalize the yuan is putting pressure on Chinese firms as the value of the yuan has begun to swing widely.

The Chinese government decided to double the trading band

The Chinese government tightly controls yuan trading, allowing it to trade only within specified trading bands. This control over the country’s exchange rate has helped the yuan become a stable currency, however, the Chinese government has been under pressure to liberalize the yuan.

Some assumed that the yuan would trend upwards in the wider trading bands. While China has been facing economic difficulty in recent months, it still arguably remains the world’s strongest major economy. So far yuan trading has been turbulent and likely will remain so in the days to come. The general trend, however, has been downwards.

Instead of trending upwards, however, the currency has taken a nose dive. The yuan dropped to its lowest level in 10 months in trading verse the dollar, and many Forex and options traders are increasingly bearish on the currency’s potential performance. Onshore spot rates fell .2 percent to 6.1624 following the widening of the trading band.

China’s economy taking a hit

China’s economy has already found itself on shaking ground over these last several weeks. Indeed, some have questioned whether or not now is the right time to liberalize the yuan, but the Chinese government has pushed forward anyways.

Now, companies could be affected by the wide swings in the yuan’s trading levels. On one hand, if the yuan weakens, exports could be bolstered, but imports, including raw materials, will become more expensive. On other hand, as the yuan gains strength, exports could be crimped.

The downward trajectory is also making it more difficult for companies to plan. In the past, the yuan was on a clear upwards trajectory, and companies knew they could rely on gradual appreciation. The new found turbulence in yuan trading, however, is complicating things.

Bonds and options are also becoming less attractive, with the gradual upwards appreciation of the yuan no longer “guaranteed”. Companies may now have trouble raising money through bonds, and loans could become less attractive.

So far, the recent declines have been relatively minor and for now the risk of a serious drop in the currency’s value remains low. For now, the Chinese government is working to control any declines and to ensure that it is a soft landing.  Some hedge funds and other traders have closed their positions in the yuan, however, as they feel that the risks currently outweigh any potential gains.

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