Anniversary of exchange rate reform: RMB weathered three depreciations

Xinhua Finance

text

Today marks the one year anniversary of China’s exchange rate reform started from August 11, 2015, when the People’s Bank of China (PBOC) decided to launch reform on the central parity price mechanism of RMB, the Chinese currency. Over the past year, RMB has experienced three sharp fluctuations. But how did the PBOC respond? And how does the central parity rate mechanism develop and what’s the future direction of RMB? This article has summarized the volatility of RMB valuation since the exchange rate reform, and included the interpretations from Guan Tao, former director of international balance and payment department of State Administration of Foreign Exchange (SAFE), who has elaborated on the achievements made during the reform in our exclusive interview.

Zhang Ming, researcher with the Chinese Academy of Social Sciences, is in the view that core contradiction of the pricing mechanism of RMB central parity rate is clearing on the foreign exchange market, especially when the PBOC drives up the exchange rate of RMB against the U.S. dollar through exchange rate control, huge amount of foreign exchange purchase demand appear, despite the market expected the RMB to continue depreciate. But due to capital control, the demand cannot be satisfied. As a result, there has been strong foreign exchange purchasing on the currency market, leading the RMB exchange rate to continue to decline.

Since August 11, 2015 when the PBOC suddenly started exchange rate reform, great changes have taken place on the currency market. The original unilateral appreciation trend was completely broken, and was replaced by RMB’s three depreciations over the past year.

As a result, the exchange rates of CNH and CNY against the U.S. dollar have declined 7.3 percent and about 6.5 percent respectively over the past year. The China Foreign Exchange Trade System (CFETS) RMB exchange rate index, which represents exchange rates of RMB against a basket of currencies, also declined 6.16 percent in aggregate.

The PBOC has taken varied policies over the past year to curb the waves of short selling of RMB.

“Compared with market operation measures such as intervention in the foreign exchange market, currently the PBOC should make more efforts to strengthen the management of RMB exchange rate, to reverse the going short sentiment on the financial market,” Lian Ping, chief economist with Bank of Communications previously indicated in an interview with us.

Tommy Dongming Xie, economist with Oversea-Chinese Banking Corporation, pointed out that though RMB still faces pressure on depreciation, it seems that the PBOC recently hoped that the RMB exchange rate could remain below 6.7 yuan per U.S. dollar. This move unintentionally send two important messages to the market: first, the central bank is setting a lower limit to the fluctuation range of RMB exchange rate, aiming to reverse the going short sentiment on the market; second, PBOC intended to increase the flexibility of RMB exchange rate in both ends, to push RMB to become an international reserve currency after it was included n SDR.

PBOC countered international speculative capitals three times

On August 11, 2016, the PBOC suddenly announced to start RMB exchange rate reform. By deprecating RMB by 1.9 percent, the deviation of spot rate and the central parity rate of RMB exchange rate was completely erased. The PBOC also guided the formation mechanism the central parity rate of RMB to a market based direction, removing the obstacles for RMB’s inclusion in the SDR.

Unexpectedly, the PBOC’s reform measures triggered continuous fluctuations of RMB exchange rate.

A foreign exchange trader recalled that international speculative capital had in total launched three short sales against RMB. The first one occurred within three days of the exchange rate reform last August. Such capital conjectured the Chinese government intentionally allows RMB to depreciate and massively sell off RMB by take advantage of the ineffective communication between the central bank and the market. The exchange rate of RMB against the U.S. dollar once sharply fell 3,000 basis points to 6.4 yuan per U.S. dollar.

The second short selling against RMB happened at the beginning of this year. After the PBOC relaxed support for RMB exchange rate, international speculative capital again started going short for RMB, resulting in the central parity rate of RMB against the U.S. dollar to decline over 900 basis points, or 1 percent.

The third short selling against RMB was ignited from April. As a series of black swan events on the financial market such as higher expectation for Fed rates hike and Brexit continue to develop, international speculative capital launched a new wave of short selling on RMB. As at the end of June, the exchange rate of RMB against the U.S. dollar dropped more than 2,400 basis points to surpass 6.7 yuan per U.S. dollar.

Many foreign exchange traders believe that in order to end the short selling, the PBOC had spent hundreds of billions U.S. dollar foreign exchange reserves. Particularly, at the beginning of the year, the PBOC utilized tens of billions U.S. dollar foreign exchange reserves to intervene the currency market. Moreover, the PBOC also tightened the CNH liquidity on the Hong Kong market, so as to raise the cost of short selling via leveraged financing, forcing international speculative capital to withdraw.

“After this successful intervention, the PBOC seems to have realized that the fighting against international speculative capital has evolved into attrition warfare of foreign exchange reserves,” said head of foreign exchange trading with a foreign bank.

Therefore, the PBOC started to change its exchange rate management strategy from this February. On the one hand, it reduced reliance on foreign exchange reserves to intervene the market; on the other hand, it took capital control measures to curb capital outflow, to ensure the total foreign exchange reserves remaining stable, and counter international speculative capital.

“Obviously, the central bank shots at the weakness of international speculative capital: only 3 trillion U.S. dollars are required to stabilize the foreign exchange reserve, and then, the said capital will be cautious, not daring to make troubles randomly.” Especially, China’s central bank has readopted measures to guide the stabilization and rebound of RMB exchange rate after it once dropped below 6.7 at the end of June, and international speculative capital has not been strong enough to directly fight against China’s central bank, the said hedge funds manager pointed out.

Rebound trend of RMB exchange rate since the end of June does not mean that international speculative capital admits its loss and gets out of the market, according to many foreign exchange traders.

“In fact, these funds are searching for new short-selling opportunities.” The central bank needs to timely adjust and deal with some problems during foreign exchange reform while preparing for solutions, Xie indicated.

Under current exchange rate formation mechanism based on “closing price and a basket of currencies”, the RMB exchange rate still lacks of sufficient flexibility, Zhang Ming, researcher at Institute of World Economics and Politics under Chinese Academy of Social Sciences, believed. In terms of reasons, “closing price and a basket of currencies” are actually two formation mechanisms for exchange rate. The former is floating one referring to closing price, and RMB exchange rate and capital flow direct to the same orientation with very strong pro-cyclicality. While the latter is the one based on a basket of currencies, and RMB exchange rate is determined by relative prices of other currencies, with main target to stabilize the growth rate of foreign trade. The two parties usually “restrict” with each other to cause an “inertial” decline in RMB exchange rate, which is always in a downtrend, no matter the U.S. dollar rises or falls.

The deep reason behind such situation is that the new pricing mode based on the central parity rate of RMB exchange rate referring to “closing price and a basket of currencies” still does not remove the core contradiction of previous pricing mechanism: clearing issues in the foreign exchange market. Especially, when the central bank rises RMB/USD rate through exchange rates management, the market still expects a constant RMB depreciation, under such situation, massive demands for foreign exchange purchase arouse as capital control is not fulfilled, hence, there is always a strong buy order for foreign exchange in the RMB exchange rate market to continuously drag down the RMB rate.

He said: “China’s central bank is still required to get rid of difficulties in exchange rate pricing after 1-year exchange rate reform.”

RMB internationalization faces “new challenges”

Many foreign exchange traders said frankly that China made greater effort for capital control last year.

“Slowing down the RMB internationalization procedure may be a cost for the central bank to maintain the RMB exchange rate stable”, in line with director in charge of foreign exchange trade at a foreign bank.

RMB took up 1.72 percent of global payment in June, the lowest proportion since October 2014, meanwhile, Hong Kong’s RMB deposit also dropped to the lowest figure since August 2013, the latest data of Society for Worldwide Interbank Financial Telecommunication (SWIFT) shows.

“RMB business growth is closely related to China’s economic activities; data shows that, in the past year, Chinese market fluctuation and slowing-down economy were very likely to influence the RMB utilization of overseas markets”, based on Alain Raes, CEO in charge of SWIFT Asia-Pacific, European and African regions.

Some branches of state-owned large banks start to set new rules for cross-border capital flow, including that deficit of foreign exchange settlement and sale must reduce month by month, or exchange settlement must be higher than sale in a single month to create “foreign exchange balance”, so that to prevent speeding-up capital outflow, an European hedge funds manager told the journalist.

Additionally, he also heard that the review & approval have been comprehensively slowed for many domestic enterprises to repay U.S. dollar based debts in advance through foreign exchange purchase. RQDII comes to a standstill, and many assets management institutions holding QDII quota suspend to issue new overseas-investment products.

Journalist also noted that the central bank had taken various moves last year to promote the RMB internationalization, such as allowing big overseas financial institutions’ investment in domestic bonds and foreign exchange markets to make their RMB assets gain stable returns to hedge exchange rate risk; and meanwhile, China’s new Cross-border Interbank Payment System (CIPS) for RMB has signed a memo with SWIFT that CIPS will access to wider SWIFT’s global users community through SWIFT channel, which will support wider RMB utilization in the offshore market.

(APD/XH FINANCE)