China has taken another step to let the yuan’s exchange rate against the US dollar be more determined by market forces, reflecting policymakers’ confidence it will continue to appreciate as foreign investors pour money into mainland financial markets and the economy continues its strong recovery from the effects of the coronavirus pandemic, analysts said.
The People’s Bank of China (PBOC), the country’s central bank, asked banks on Tuesday to remove the countercyclical factor (CCF) from the formula they use to calculate estimates for the daily central parity for the yuan, which they submit to the PBOC for final determination every morning.
The daily parity rate forms the midpoint of the yuan’s daily trading range against the US dollar, with the Chinese currency allowed to rise or fall by 2 per cent on either side.
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The PBOC’s decision to stop using the countercyclical factor in the daily parity rate – a formula for maintaining control over the yuan’s exchange rate, the exact content of which has never been disclosed – comes after the yuan’s performance in the third quarter was the best in 12 years.
Foreign investment has been pouring into Chinese equities and bonds because higher interest rates are making yuan-denominated assets more attractive globally.
For instance, the Chinese government’s 10-year bond is yielding 3.16 per cent, while the US Treasury 10-year bond offers only 0.81 per cent and the German government’s 10-year bund rate is negative 0.62 per cent.
In addition, the Chinese export boom in recent months is bringing in huge piles of cash from sales of consumer electronics driven by the work-from-home movement, as well as medical equipment and pharmaceutical ingredients being used to fight the pandemic.
“The time has come [for China] to fix the abnormal environment of the past two years,” said Li Liuyang, chief currency analyst at China Merchants Bank. “The first step is to phase out all the RMB depreciation-preventive policy measures that were implemented. Then, market opening and RMB internationalisation should be further promoted.”
RMB, an abbreviation for renminbi, is another name of the Chinese currency.
On Wednesday, the yuan was exchanging hands at 6.7111 against the US dollar, little changed from Tuesday.
The PBOC’s last suspension of the CCF was in January 2018 after a strong rally in the yuan that started at the end of 2016. This meant state banks effectively gave up their influence to support the value of the currency, allowing their quotes to reflect current buying and selling forces in the market.
The use of the CCF resumed again in August 2018 when the yuan was facing strong depreciation pressure due to the US-China trade war that started in July that year.
Its latest removal could herald bigger market reforms to lure foreign investors underscoring Beijing’s determination to relax market restrictions, analysts said.
“As the RMB reversed its deprecation trend months ago, the CCF adjustment is no longer an appropriate tool to manage the foreign exchange risk
Ken Cheung Kin-tai
Earlier this month, the government scrapped a reserve requirement that had made it more expensive for financial institutions to trade foreign exchange forwards – a financial derivative that allows traders to bet on the yuan’s future value – freeing up firms to support the yuan’s rise.
It also announced fresh quotas under its outbound Qualified Domestic Institutional Investor scheme in September, allowing domestic investors buy offshore securities after halting such issuances for over a year.
“As the RMB reversed its deprecation trend months ago, the CCF adjustment is no longer an appropriate tool to manage the foreign exchange risk,” said Ken Cheung Kin-tai, chief Asian currency strategist East Asia Treasury Department at Mizuho Bank.
“The RMB appreciation trend will help promote the China domestic market to foreign investors under the dual circulation development plan, and we look for more room for RMB appreciation in the medium term in our base scenario of [US presidential candidate Joe] Biden’s victory.”
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