(MENAFN- Gulf Times) The best way to stem the capital outflows from China is to keep the yuan stable, according to Goldman Sachs Group.
China's strategy to weaken the currency periodically is unsustainable because such a depreciation leads to market selloffs and accelerated capital outflows, which in turn tighten financial conditions in the country contrary to broader policy goals, strategists led by Robin Brooks wrote in a note last week. That suggests China may prefer a stable yuan to a "large, one-off" devaluation going forward, buoying global assets such as US stocks and the dollar, the strategists wrote.
China's policy makers "are 'learning' that their room for manoeuvre on the currency is extremely limited and that RMB weakness is, in many respects, counterproductive," they wrote, referring to an abbreviated name for the yuan. "Given that regulatory measures to stem outflows may ultimately prove insufficient, the best way to slow capital flight is to signal stability" in their daily reference rate "at least for the foreseeable future," they said.
Policy makers have strengthened the yuan rate, known as fixing, since early January, after weakness in previous months helped quicken capital outflows and roil global financial markets. The central bank has burned through more than $400bn in foreign reserves to prop up the yuan since a surprise August devaluation, raising concern that the cash stockpile may soon fall below adequate levels.
Brooks' team said China is far from losing control over the yuan market. With its current account surplus, capital outflows need to reach more than $350bn annually before central bank has to deploy any of its $3.2tn reserves, the strategists wrote.
The recent experience shows that outflows have accelerated during periods of yuan weakness and abated in times of currency stability, they said.
"This is not a balance of payments that is out of control," Brooks wrote. "Capital outflows are not some exogenous number, but are expectations-driven and thus a function of what policy makers signal via the fix."
The yuan may trade between 6.6 per dollar and about 7 per dollar by year-end, according to Goldman Sachs. That compares with 6.5755 per dollar on February 5 when the local markets were closed for the Chinese New Year holiday. The 12-month forwards traded at 6.7835 per dollar, about a 4% discount to the official fixing.
A stable yuan should help the Standard & Poor's 500 Index of US equities to rally about 8% to 2,000, according to Brooks. The yen will weaken to 125 per dollar, from 113.6 Wednesday, while the euro may drop to $1.04, from $1.1271, ahead of the European Central Bank meeting on March 10.
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