From Rich Miller and Enda Curran at Bloomberg:
The yuan has advanced almost 15 percent against a basket of currencies since mid-2014, according to a trade-weighted index compiled by Westpac Strategy Group in Sydney. The rise came at a time when China was already losing competitiveness to countries such as Vietnam and Thailand because of its higher labor costs.
….The result of the currency’s recent rise has been slower economic growth. GDP expanded 6.9 percent in the third quarter from a year earlier, its worst performance since early 2009, as the drag from weaker manufacturing and exports offset strength in services and consumption.
A stronger currency also hampers China’s efforts to ward off deflation because it puts downward pressure on import prices…… “China will continue to face deflationary pressure, particularly in its manufacturing sector” if the yuan continues to appreciate along with the dollar, Xiao Geng, a professor at the University of Hong Kong, said in an e-mail. He nevertheless expects China will avoid depreciating its currency on concern that such a move would upset fragile domestic financial markets.
Another reason to hold the yuan steady against the greenback: a build-up in dollar-denominated debt by Chinese companies. A cheaper yuan makes it tougher for them to service those obligations.If China does elect to retain its currency regime, it must be prepared for a further broad rise of the yuan in line with the dollar.
China appears locked in to its peg against the Dollar but a strong Dollar/Yuan hurts exports. So it looks like the PBOC has opted to sell down foreign currency reserves in order to slow appreciation of the Dollar, while maintaining the peg. But reserves have already fallen by half a trillion Dollars and the outflow is likely to accelerate when the Fed raises interest rates. They are in for a wild ride.