Trade Resources Market View A Wider Daily Trading Range Won't Make The Yuan a More Flexible Currency

A Wider Daily Trading Range Won't Make The Yuan a More Flexible Currency

Starting Monday the value of the renminbi will be allowed to fluctuate 2% above or below a daily reference rate set by the People’s Bank of China. Widening the band, which had a 1% range in both directions since April 2012, was a long-expected move – and largely a ceremonial one.

A wider daily trading range won't make the yuan a more flexible currency. Despite the flexibility to move by 1% from the daily reference rate during the past two years, the biggest day-to-day change in the rate last year was just 0.21%, according to London-based Capital Economics.

“In 2013, for example, the renminbi moved by close to the full extent of the 1% band almost every day. But the reference rate barely changed and, as a result, movement from one day to the next was far more constrained,” the note said.

As long as the central bank still determines the rate at which the currency begins trading each day, it will remain strictly under PBOC control. The downward movement of the yuan since the beginning of the year shows just how easy the yuan is to manipulate.

Since January, the bank has been buying up US dollars in order to let the renminbi depreciate then setting the reference rate lower each day. The goal is to show traders who were bringing large stacks of redbacks into the country that the yuan can fall in value too.

A wider trading band won't stop the PBOC from engineering the direction of the currency in the future. Some analysts have argued that the baby step toward liberalization isn't even necessary. The move will, however, introduce a new level of intraday volatility into the foreign exchange market, making the yuan look more like a freely traded currency. When PBOC widened the band from 0.5% to 1% nearly two years ago, the yuan rallied during a major political meeting between the US and China then weakened as the eurozone deteriorated – a reaction to events that currencies such as the dollar experience.

What's different today is that the yuan is not greatly undervalued. Two years ago, most analysts agreed that China was holding down the value of the currency to promote exports. Such accusations, most notably from the US government, have quieted since party boss Xi Jinping took full command of the government. Many investment banks still place their bet on a strong yuan at the end of 2014.

More important than the short-term ups and downs is the central bank's resolve to follow through with the reforms it has promised. Widening the trading band is part of that.

PBOC has a full agenda for the next five years which includes making the yuan a freely traded currency and scrapping a cap on deposit rates. To make a real impact, the central bank will need to let the market decide the daily reference rate that the currency trades at. Bank of America Merrill Lynch analysts noted Singapore's success with the so-called BBC, or “basket, band and crawl,” that pegs the Singapore dollar to a basket of currencies weighted by the importance of the trading partner.

“In this regime, the compositions and weights of the basket is not disclosed, and the width of the band is undisclosed [too],” according to BAML. “Both the basket and band are revised periodically to take into account changes in trade patterns and economic changes. The exchange rate floats within a set band with a pre-set policy on the direction of ‘crawl’ (up, flat or down). The purpose of such a band is to prevent sharp fluctuations.”

No one expects the Chinese central bank to give up that much control in 2014.

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China Surprises Nobody as It Widens Yuan Trading Band