The sky has not fallen in since China let the renminbi weaken through the barrier of Rmb7 to the US dollar in early August, but there is no room for complacency. 

Demand from households to shift out of renminbi assets may not have spiked in the wake of the most recent bout of depreciation, but it has been building. Even if the financial system appears calm, the People’s Bank of China still faces internal and external risks that could lead to  2015-16 redux. 

The renminbi fell nearly 4 per cent against the dollar in August after US president Donald Trump’s  latest salvos in his trade war led the Chinese authorities to relax their defence of the exchange rate. 

Last year’s efforts to defend Rmb7 imbued this arbitrary line in the sand with far too much importance. Abandoning it was sensible because insisting on its defence threatened to become a slog and an unnecessary drain on foreign exchange reserves. 

The onshore renminbi is now trading firmly on the weaker side of the daily midpoint, which is set by the PBoC with a tolerance band of 2 per cent either side. The central bank appears to be supporting the currency in onshore trading through its morning fixing of the daily midpoint, despite market attempts to push it lower. 

So far, so good

If 2015-16 is a benchmark for gauging turmoil, then China’s financial system remains relatively calm. Our August household survey, which asks 1,000 urban residents how much foreign exchange they would hold if there were no capital controls, did not show a sharp spike in demand. 

While official August numbers are not yet available, foreign exchange reserves remained stable during the first seven months of this year, while net sales of foreign exchange to banks by customers have been within average levels, suggesting limited demand from households and companies. 

The situation has been helped by the PBoC’s improved communications. The renminbi devaluation in August 2015 rocked global markets because the move, which came on the heels of a stock market collapse, was so sudden and the central bank failed to communicate its intentions clearly. 

In the run-up to the devaluation in early August, officials played down the importance of Rmb7, while central bank governor Yi Gang quickly said in a statement that the currency was at an “appropriate level”

Growing demand

Despite the relative calm since 2016, household demand for foreign exchange has only increased, if at a gradual pace. 

This reflects factors such as the growth of  outbound Chinese tourism and overseas education, as well as a natural diversification of savings out of renminbi. 

But fears about a weakening currency are also fuelling demand for foreign exchange.

The need to hedge against a renminbi weakness was the third most popular reason — and chosen by a third of respondents — for using the $50,000 annual foreign exchange quota for residents (the proportion rose to 40 per cent among respondents from our highest income group, and those from the first-tier cities of Beijing, Shanghai, Guangzhou and Shenzhen). 

Although more than half of respondents said they did not use their foreign exchange quotas at all last year, only 41 per cent said they did not expect to do so this year.

Among our highest income group, reporting annual household income of Rmb300,000 or more, 14 per cent said they expected to max out their quota this year. 

Not all of this is for personal use — despite rules against the practice, 14 per cent of all respondents who said they had tapped or expected to tap their quota admitted doing so on behalf of others. 

Vigilance the watchword

The survey results are not an exact guide to how much Chinese households intend to convert. 

If the 9 per cent of respondents who said they expected to use all their quota this year were reflected nationwide, it would imply just over $3tn in outflows, or nearly all of China’s foreign exchange reserves. 

Nonetheless, the result illustrates the growth of underlying household demand, which the government must keep in check in the face of depreciation pressures and the  threat of renewed outflows

A tight lock is kept on capital account transactions because of the fear that money could flee China faster than the monetary authority could replace it, meaning more renminbi weakness, a drain on reserves and a destabilised financial system, which could dangerously undermine the government’s authority. 

While the collapse of the Suharto regime in Indonesia in the late 1990s offered Beijing a lesson in the dangers of unrestrained capital flight, even the government’s most reform-minded economists have argued that the capital account must be kept relatively closed until the domestic financial system is cleaned up. 

Capital controls are notoriously porous, but the regulatory and administrative crackdown in the wake of the 2015 and 2016 turmoil did prove a reasonably effective deterrent. 

An associated policy response was to stabilise the renminbi exchange rate, changing household and corporate depreciation expectations through the introduction of what the PBoC said was a “countercyclical factor” in calculating the renminbi’s daily midpoint — setting it stronger against the dollar rather than strictly following the calculation formula, which would result in weaker fixing rates. 

While the PBoC continues to try to control depreciation, the renminbi’s longer-term trajectory depends on a host of factors. 

With the growth outlooks for the US and eurozone economies diverging, the euro may continue to weaken, which could push the dollar index higher, implying further renminbi weakness. 

China’s economy is still slowing, and the government’s reluctance to introduce aggressive stimulus until now suggests that growth will continue to decelerate. The US-China trade war looks set to escalate — the latest US tariffs on Chinese goods went into effect on September 1 — strengthening the internal argument for more renminbi weakness as a counterweight. 

This all means that the Chinese government will continue to limit capital outflows, while also continuing to  encourage inflows. This is a precautionary stance aimed at meeting the current policy priorities of stabilising growth, preventing financial risk and capping debt levels. 

Despite the government’s internationalist ambitions, its 13th five-year plan, which runs until the end of next year, includes only non-committal language about taking “systematic steps to realise renminbi capital account convertibility”. 

That is just as well, because the turmoil of the plan’s first few years, and the uncertainty that has followed, mean the leadership will need to continue to err on the side of caution.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combines findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.