Selling yuan advised by Deutsche Bank to Barclays on flows

Cheap Credit

Foreign-direct investment rose 0.3% to $9.26 billion in May from a year earlier, the smallest gain in four months, the Ministry of Commerce said in a statement in Beijing today.

The unwinding of the yuan carry trade could “end an important source of cheap credit for China,” the Deutsche Bank analysts wrote in their June 11 research note.

The yuan’s recent appreciation “suggests that the Chinese government feels the economy is stronger than most believe,” Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley Asia, said by e-mail. “Otherwise, it wouldn’t be condoning a development that might inhibit export growth.”

Room to Appreciate

Eswar Prasad, a former IMF official who teaches economics at Cornell University in Ithaca, New York, said there is still room for the yuan to appreciate as the economy recovers in the second half of the year.

Chinese growth will hold at 7.8% this year, maintaining the slowest expansion since 1999, according to the median forecast of 53 economists surveyed by Bloomberg. China is still expanding faster than the average 6.4% rate across Asia, the survey showed.

The median estimate of 49 analysts surveyed by Bloomberg is for the yuan to strengthen to 6.1 per dollar by year-end, and rally further to 6 by the conclusion of 2014.

“Fundamentals in China are better than many other emerging markets,” Prasad said in an interview yesterday. “That’s why we are seeing the yuan performing better than the other Asian currencies.”

Band Widening

As speculative capital retreats, it’s a “propitious time” for policy markets to widen the currency’s trading band, loosening control over the yuan, he said. The yuan is closer to its fair value in terms of trade balance, and it’s a priority for the central bank to make the currency a two-way bet to increase room for further reforms, Andrew Colquhoun, the head of Asia-Pacific Sovereigns at Fitch Ratings, told reporters in Hong Kong today.

Growth in the world’s largest economy after the U.S. is losing momentum. Exports increased 1% in May, after gaining 15% the previous month, government data June 7 showed. Industrial production rose 9.2%, trailing the median forecast of 9.4% among 39 economists surveyed by Bloomberg.

Interbank funding costs soared this month on speculation the Chinese authorities are moving to rein in credit to avoid bad loans. The seven-day repurchase rate, a gauge of interbank funding availability, has averaged 6.11% in June, the most since the National Interbank Funding Center began compiling a weighted average in 2006.

“We are in a moderately tightening cycle,” said Traxis Partners’ Bisat. “The strengthening of the fixing is part of that story.”

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