It’s five years since China’s then-leader Hu Jintao bashed the international monetary system as “a product of the past”. He took particular aim at the dominance of the US dollar and the dangers of the Federal Reserve’s loose monetary policy. Times have now changed, of course, but shortly before the Fed took its momentous decision to raise rates by 25 basis points last month, China’s currency bosses renewed their push for a dollar divorce.
The goal: a future in which the yuan’s exchange rate is shaped by Chinese trade and investment with a wider range of countries, and not just with the United States.
The desire to part ways with the dollar was heralded by the central bank’s launch of a new index. It’s provided by the China Foreign Exchange Trade System, a division of the People’s Bank of China, and measures the yuan’s performance against a basket of 13 currencies, based on the daily spot quotes from the CFETS trading platform.
Officials have said that they hope the arrangements will encourage the market to think about the renminbi in a “more comprehensive and accurate” way. “For quite long, market participants have used a bilateral exchange rate of RMB against USD to assess RMB exchange rate movements,” the statement from the central bank noted. “However, as fluctuations of exchange rates serve to adjust trade and investment activities with multiple trading partners, the bilateral RMB-USD exchange rate is not considered a good indicator of the international parity of tradable goods.”
Behind the jargon is frustration that the focus on how the yuan is faring against the dollar fails to take account of its performance against other currencies. The redback lost more than 4% against the greenback last year, for instance, but actually advanced against 12 of the 16 major currencies tracked by Bloomberg over the same period.
The authorities also want to move away from the soft peg to the dollar because of the prospect of more rises in interest rates in the US. If the de facto link is maintained, rate hikes from Washington will pull the renminbi higher.
But the composition of the new basket hints at Beijing’s policy priorities too, according to HSBC’s currency analysts. About 69% of the index’s weight has been allocated to the G3 heavyweights – the dollar, the euro and the yen – and only 16% to emerging markets, where the Malaysian ringgit, the Russian rouble, the Thai baht and the Singaporean dollar feature. That suggests that the Chinese are more concerned about the yuan being overvalued against the G3 currencies than its competitiveness against those of emerging markets, the HSBC experts believe.
None of this debate seems to have discouraged the broader question – and the kind of query that the PBoC would like to hear a little less in future – about how the yuan will fare against the dollar in 2016.
A common prediction is more volatility in exchange rates as Chinese authorities intervene less. Accordingly, the yuan fell sharply following the announcement of its inclusion in the International Monetary Fund’s Special Drawing Rights programme last month (see WiC306), a move presaged to mean less meddling by the central bank. This week there were more declines and the yuan is now at a five-year low against the dollar.
Still, most market watchers are anticipating more weakening, notwithstanding the fact that the Chinese have been spending about $100 billion a month in foreign reserves to prop up the yuan’s value.
While Beijing won’t mind a little softening against the dollar, it doesn’t want a disorderly decline, following the international concern over the unexpected 2% devaluation that accompanied the introduction of a more market-based mechanism to determine the exchange rate last August (see WiC292).
Policymakers worry that a dramatic drop in value could ignite trade tensions overseas and prompt another surge in capital flight as those with the means flee the renminbi on fears that its value could erode further.
Worth 6.49 against the dollar in the Chinese markets at end of 2015, the yuan will weaken to 6.70 by the end of the year, HSBC is forecasting, as interest rates strengthen in the US and China’s economy continues to slow.
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