CASE STUDY China’s Pegged CurrencyOver the first decade of the .docx
Background of Yuan depreciation and central parity reform
1. Background of RMB depreciation and central parity reform
2015-8-15
The adjustment of RMB central parity, is an active rather than passive devaluation adjustment. To
talk about the initiative of central parity adjustment, we have to discuss the background of central
parity reform of USD/CNY.
1. the Duality of formation mechanism of the RMB central parity.
Managed floating exchange rate system was officially launched in 1994, marked the official
launch of RMB exchange rate reform. From July 21, 2005, to further improve the exchange rate
regime, a market-based managed floating exchange rate regime, which was referred to a basket of
currencies, was implemented. In June 19, 2010, People's Bank of China decided to further reform
RMB exchange rate formation mechanism, strengthen the RMB exchange rate flexibility. At
present, the daily fluctuation range of USD/CNY is 2% around central parity rate according to
central bank resolution in March 17, 2014. So the central bank can manage USD/CNY currency
rate by locking in USD/CNY central parity.
Before august 11, 2015, the formation of USD/CNY policy was: "The trading center inquiry to the
foreign exchange market maker before interbank forex market opening, and make the whole
market maker quotes as the sample , excluding the highest and lowest offer, the USD/CNY central
parity is the weighted average of remaining market makers quote. weighting of the composition is
determined comprehensively by the trading center according to the market trading volume and
quotations. " However, the relevant information of market maker quotes, weight and other
information are not available, therefore, the USD/CNY central parity is regulated by the central
bank for a large extent. the central bank did maintain the stability of USD/CNY exchange rate
through the control of central parity.
By analyzing USD/CNY central parity between February 16 to February 27(Figure1), its clearly
that with ten consecutive trading days, the market closing price is close to 2 percent fluctuation
limit, but the central parity return back to the original value in the next day, and the exchange rate
market closing price hit the limit again. During this period, due to the control of the central parity,
the RMB fell only 0.2%. This strange phenomenon reflects the lack of transparency of the central
parity, the market plays a limited role of the CNY formation.
Therefore, both market and control mechanism exist in the RMB/USD central parity policy before
the reform.
2. Figure1: USD/CNY Currency rate
2. the marketing reform of USD/CNY central parity
August 11, 2015, the formation of the central parity mode change occurs, central bank of China
issued a statement saying that since August 11, 2015, central parity is formed referring to the forex
market closing rate, currency supply and demand as well as changes of major international
currency exchange rates.
on August 11, USD/CNY central parity rate is 6.2298, depreciated by nearly 1.85% compared
with the central parity of 6.1162 on August 10. on August 12, the central parity rate again
depreciated nearly 1.62%.
Figure II: The change of USD/CNY central parity rate since policy reform
3, the background of USD/CNY depreciation
3.1 reaction to the pre-expected depreciation
In 2014, the central bank repeated quantitative easing monetary policy, the four "rate cut"; two
2015
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收盘价 marking closing 6.258 6.258 6.259 6.255 6.255 6.255 6.255 6.255 6.255 6.248
USD/CNY中间价central
parity
6.147 6.137 6.138 6.138 6.138 6.138 6.138 6.138 6.133 6.127
2%波动幅度限制
2%fluctuation limit
6.270 6.260 6.261 6.261 6.261 6.261 6.261 6.261 6.255 6.249
6.05000
6.10000
6.15000
6.20000
6.25000
6.30000
5.95
6
6.05
6.1
6.15
6.2
6.25
6.3
6.35
6.4
6.45
USD/CNY parity rate
USD/CNY
3. "comprehensive deduction of RRR"; three "targeted RRR deduction."
Adjust time Deposit rate Mortgage rate
2015.06.28 ↓0.25% ↓0.25%
2015.05.10 ↓0.25% ↓0.25%
2015.02.28 ↓0.25% ↓0.25%
2014.11.22 ↓0.25% ↓0.4%
Table 1: timetable for 4 interest rates cut
Source http://finance.sina.com.cn/focus/yhndscjx/
Time DDD Range Keywords
2015.06.28 targeted,
agriculture 0.5%,
0.5% of small and micro enterprises,
financial companies 3%
2015.4.20 1% Comprehensive reduction 1%；
targeted rural financial institutions
2015.2.05 0.5% Comprehensive reduction
0.5%；
targeted small micro-enterprise loans
Table II: RRR reduction timetable since 2014
http://www.csai.cn/yinhang/774996.html
the quantitative easing monetary policy has brought greater devaluation pressure, however, the
USD/CNY exchange rate has remained stable since 2015. A major reason is since 2014, the
surplus of balance of payments have changed, the current account surplus narrowed, capital
outflows, foreign exchange reserves shrink (Figure III-1). In order to reduce the pressure of
foreign capital outflow, Chinese central bank had to sell foreign exchange reserves to ease
through devaluation pressure, reflected in the foreign currency reserve continues to decrease
(Figure III -2), the RMB has been caused to remain stable.
5. Figure 4: China Caixin manufacturing PMI (formerly HSBC manufacturing PMI) (monthly)
http://dc.xinhua08.com/85/
Figure VII: the growth rate of accumulated fixed assets investment
http://data.stats.gov.cn/easyquery.htm?cn=A01
3.2 RMB devaluation to boost exports is a last resort to ease economic downward pressure
Despite the easing of monetary policy, the real economy remain week because of weak demand,
further increase downward pressure on the domestic economy.
the three carriage of economic, consumption, investment and exports have showed a "stable, weak,
weak" performance. Consumption has a steady trend, growth in social consumption has grow
steadily (Figure 6). on the aspect of investment, since June 2014, new manufacturing PMI index
has continued downward (Figure 4). In July 2015, the figure has hit the lowest point of the year.
At the same time, the cumulative growth rate of fixed assets have declined since 2015 (Figure 7).
on the aspect of exports, the dollar index has been increasing since 2014 (Figure 5), due to the
stable USD/CNY rate, the RMB has been passively appreciated against the euro, yen and other
currencies. The export to EU and Japan, which is China's largest and the fifth largest trading
6. partner, has declined because of the reduced competition of RMB. China's exports have emerged a
comprehensive decline since July, 8.3% decrease on a year-on-year base, and 0.8% decrease from
January to July. Meanwhile, China's exports continued to decline in the leading index. In July, the
leading index of Chinese exports was 34.1, down 0.7 compared with June, which is the fifth
consecutive monthly decline. this indicate that China's export pressure is still large in the third
quarter.
Figure 5: US dollar index
http://finance.sina.com.cn/money/forex/hq/DINIW.shtml
Figure 6: monthly growth rate of total retail sales
http://www.stats.gov.cn/tjsj/zxfb/201508/t20150812_1229265.html
in the background of economic downturn, reduced effectiveness of domestic monetary policy, to
maintain stable exports, devaluation is a last resort to boost economy. The United States and Japan
have adopted the same currency devaluation way to stimulate the economy and exports in the
7. economic downturn. Compared with 2012, yen depreciated by nearly 40%, if the currency
competition equivalent of the competitiveness of export, China's economic competitiveness have
fallen by nearly 40%( figure VIII).
Figure VIII: JPYCHY daily K line chart
http://quote.forex.hexun.com/JPYCNY.shtml
3.3 the marking reform of RMB central parity may coincide with the efforts to obtain SDR
China has pushed the inclusion of RMB in IMF special drawing rights(SDR) currency basket, the
formal decision will be fastest made in the end of October 2015. If successful, China will become
the the fifth international reserve currency gain SDR. To join the SDR basket of currencies, two
criteria must met: "First, currencies issued by members or currency unions whose exports of goods
and services had the largest value over a five-year period, second, the currency have been
determined by the Fund to be "freely usable.""
IMF released a report, " REVIEW OF THE METHOD OF THE VALUATION OF THE
SDR—INITIAL CONSIDERATIONS" the report said that "at the time of the last review(2010),
China met the gateway export criterion (Figure IX ) but the renminbi (RMB) was not included in
the SDR basket as it was not judged to be freely usable", freely usable currency is one that "the
Fund determines (i) is, in fact, widely used to make payments for international transactions and (ii)
is widely traded in the principal exchange markets". IMF also worries the operational issues arose
by the deviations between the offshore (CNH) and onshore (CNY) RMB exchange rates
Deviations between the two rates imply that the CNH cannot be a perfect hedge for CNY-based
exposures.( Figure 10) " "The increasing opening of the capital account should help to further
reduce CNY-CNH divergences in the future. "
Therefore, in order to meet the IMF requirements for free usable requirement, the central parity
market reforms will no doubt indicate the RMB accelerate the process of marketization, which is
necessary movement to join the SDR.
8. Figure IX: States exports of goods and services accounted for global share
http://www.imf.org/external/np/pp/eng/2015/071615.pdf
Figure 10: onshore RMB (CNY) and offshore RMB (CNH) difference
Source: Wall Street knowledge
