While the markets are beset by concerns that the Chinese yuan could weaken substantially following its 7 percent depreciation against the US dollar in 2016, we are adhering to our view that managed depreciation will be achieved in 2017, much in the same way as over the last year.

It is worth bearing in mind that it is still a largely controlled currency despite the shift to a more flexible ‘managed float’ regime in August 2015 (the 2 percent daily fluctuation limit is largely academic – the Yuan has weakened by around 12 percent against the US dollar since then).

Nonetheless, capital outflows have increased again, so further depreciation is on the cards but we think that it will continue to be very gradual. Fears about capital outflows intensifying significantly have prevented the PBoC from allowing steeper depreciation and this is likely to be the case in the future, especially in view of the stronger USD backdrop and a more confrontational relationship with the Trump administration.

Another factor that we have been highlighting for some time is outbound investment exerting weakening pressure on the Yuan as it will continue to outpace foreign direct investment (outbound direct investment was 1.07 trillion Yuan, $161.6 billion, in January-November 2016, up 55.3 percent y/y, while FDI in the period amounted to 731.8 billion Yuan, $110.5 billion, up just 3.9 percent y/y). So the authorities are now clamping down on “irrational” investment abroad, especially by corporates.

But now the authorities are probably even more worried about capital outflows accelerating, consuming ever-bigger chunks of the official reserves, which saw a bigger than expected $69.1 billion drop to $3,051.6 billion in November. While there is still a desire in some policy circles in China to let the currency weaken more substantially to support flagging exports (the commerce ministry has been a key proponent of this view), there is also recognition of the reality that this would be unlikely to boost exports markedly as well as of the risks.

Meanwhile, trade flows will continue to be Yuan-supportive although the current account surplus, which is lower than the trade surplus, is likely to decrease over time (the current account surplus in the first three quarters of 2016 was $174.7 billion, considerably higher than the capital/financial account deficit of $85.7 billion).

However, expectations of Yuan depreciation have become entrenched because of the relenting, albeit relatively mild, pace of currency depreciation against the US dollar, and we still think that the Yuan will be allowed to carry on weakening against the US dollar, not least because of higher capital outflows.

The focus on the trade-weighted currency basket also means that weakening of the Yuan against the basket will be tolerated too. But we would also reiterate that the central bank has often stressed its desire to see a two-way market in the Yuan and a “flexible” exchange rate, which means more fluctuations in both directions, albeit fairly small ones.