Even the Resilient Yuan Is Feeling China's Pain

Tomohiro Ohsumi | Bloomberg | Getty Images

China's resilient yuan has fallen this week to its lowest level in more than a month, finally succumbing to jitters about signs of weakness in the economy.

The yuan on Tuesday weakened to about 6.15 per dollar, its lowest level since mid-May and off a record high hit late last month of around 6.12.

Analysts say the yuan, which has held up relatively well compared with its Asian currency peers in the face of a broadly-robust dollar, is also facing downward pressure from the heavy sell-off in equity markets this week and jitters about a credit squeeze faced by local lenders.

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"We have been looking for a correction lower in the yuan for a few reasons," said Mitul Kotecha, head of global currency research at Credit Agricole in Hong Kong. "Its upward move had looked overly rapid at a time when other Asian currencies were weakening. Also, economic growth has been weakening and that has added a weakening bias to the currency."

Concerns about China's economic outlook have grown in recent weeks as data proved largely disappointing. A number of economists have cut their forecasts for gross domestic product growth this year, while comments from China's new government suggest Beijing is happy to tolerate a slower rate of growth as long-term structural reforms take place.

Data released last week for instance suggested that activity in the manufacturing sector is contracting.

A credit crunch in Chinese money markets and a tolerance by the central bank of the tight liquidity conditions meanwhile have heightened concerns about growth, helping send Shanghai's benchmark stock index to its lowest level in more than four years on Tuesday.

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"At this stage it [the credit squeeze] does add to downside risks for the Chinese economy this year and a weaker-than-expected renminbi over the medium term," Jonathan Cavenagh, senior FX strategist at Westpac Bank told CNBC Asia's "Cash Flow" earlier this week.

"The renminbi has really outperformed the rest of the Asian currency block over the past one to two months and I really don't see that being sustained," he added.

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The yuan, which is also known as the renminbi, is up about 1.4 percent against the greenback so far this year. It has proved resilient even as other Asian currencies fall sharply against the dollar on expectations for an unwinding of the Federal Reserve's monetary policy stimulus program this year.

Take a look at the Malaysian ringgit, one currency that has tracked the yuan closely in the past. It's down 4 percent against the dollar so far this year, while the Indonesian rupiah has shed about 3 percent and the South Korean won is down 8 percent.

"Given what's happened with Chinese economic data, the credit squeeze, the weak stocks, people are going on the view that the appreciation story for the yuan is now over and are getting out of long positions," said Craig Chan, head of currency strategy for Asia at Nomura.

Credit Agricole's Kotecha said his model for the yuan, which took into consideration factors such as the U.S. dollar's performance and Chinese stocks, pointed to a weaker yuan in the months ahead.

The Chinese yuan is currently allowed to rise or fall by 1 percent in either direction from a level fixed against the dollar each day by the country's central bank.

"We see the yuan underperforming against the dollar and on an intra-Asia level in the next one to two months," said Westpac's Cavenagh.

— By CNBC.Com's Dhara Ranasinghe, Follow her on Twiiter: @DharaCNBC