Markets have been spooked this week by competing fears that 1) China has embarked on a major devaluation push and 2) large-scale capital outflows will undermine the authorities’ commitment to a stable exchange rate.

The recent fall in the yuan against the US dollar is not a compelling reason for believing the first proposition. China changed its exchange rate policy in August, switching focus from the dollar to a trade-weighted basket. A mini-devaluation was allowed to correct a rise in the yuan against the basket earlier in 2015, while the authorities indicated an expectation of stability going forward. Details of the basket were revealed in December with the introduction by the China Foreign Exchange Trading System (CFETS) of the RMB index. CFETS releases weekly updates of the index value but it is straightforward to calculate it on a daily basis. The index today (8 December) stands at an estimated 99.94 versus its base value of 100 on 31 December 2014 – see chart. This is, however, slightly below a low of 100.25 reached after the August mini-devaluation – see chart. The fall in the yuan against the dollar to date, therefore, is explicable by generalised US currency strength rather than an independent Chinese decision to devalue, although a further decline in the RMB index would question this interpretation.

The authorities continue to indicate an expectation that the RMB index will remain “relatively stable” and there are numerous arguments against a devaluation. Chinese exports are outperforming in US dollar terms. The current account surplus is forecast by the IMF to have reached $348 billion, or 3.1% of GDP, in 2015. A lower exchange rate would run counter to the aim of rebalancing the economy away from exports / industry towards consumption / services. China is enjoying a large positive terms of trade shock from lower commodity prices, implying a higher, not lower, equilibrium exchange rate. A devaluation would lead to further downward pressure on competitor currencies and could depress global growth via negative confidence / financial spillovers, suggesting little short-term boost to the Chinese economy.

China may not be seeking to devalue but will the scale of capital outflows undermine the commitment to stability? Foreign exchange reserves fell by $108 billion in December alone, with the decline mitigated by valuation effects. Pessimists claim that there is still a large overhang of long “carry trade” positions in the yuan, the liquidation of which will overwhelm official intervention. This claim is questioned by balance of payments data. Between the start of 2005 and the end of the third quarter of 2015, China ran a cumulative current account and foreign direct investment (FDI) surplus of $4.2 trillion. Official reserve assets, meanwhile, rose by $3.2 trillion. The non-FDI capital account excluding reserves, therefore, was in deficit by $1.0 trillion. This deficit argues against the existence of a large outstanding long carry trade. Rather than an unwind of long positions, recent capital outflows may reflect speculators shorting the yuan in the expectation of officially-sanctioned depreciation. With a semi-closed capital account, an annual current account / FDI inflow of $350-400 billion and remaining reserves of $3.3 trillion, the authorities are very unlikely to be overwhelmed by such speculation. Any decision to devalue will be voluntary.