China's new yuan-fix scheme shows stable currency still top priority
Slim reserves and concern over US rate hike moved central bank's hand
YUSHO CHO, Nikkei staff writer
SHANGHAI -- A coming shift in how China sets the midpoint rate for yuan trading is meant first and foremost to curb pressure weakening the currency, staving off a resurgence in capital flight as the U.S. prepares to hike interest rates.
The People's Bank of China has been communicating with banks this week to explain a new method for calculating the yuan reference rate it releases each morning, which acts as a midpoint for the day's currency trading. The central bank bases the rate on quotes from more than 10 major banks.
These banks' quotes for the rate are currently based on the yuan-dollar rate at 4:30 p.m. Beijing time, which is then adjusted to reflect shifts in a basket of currencies overnight. While the specifics of the new formula have not been revealed, factors including the previous day's reference rate will apparently be added to banks' consideration, ensuring that changes in that rate are fairly moderate day to day. According to one bank, the scheme will lead to smaller changes in the rate when the yuan depreciates than when its value increases -- a clear sign that the change aims largely to fend off slides in the currency.
Taking back control
China's central bank in August 2015 announced out of the blue that it would start basing the daily rate calculation on the previous day's close, aiming to align its guidance more closely with market sentiment. This step toward greater transparency was designed in part to appeal to the International Monetary Fund, which at the time was considering the yuan for inclusion in the currency basket underpinning its reserve asset, known as special drawing rights. The yuan's value sank sharply in the days after the change.
The PBOC said in February 2016 that the yuan's movement against a basket of currencies had been added to the calculation.
The latest move is a step back from these attempts to give markets a greater say. A dive in the yuan and hefty capital outflows are still real threats. The yuan has weakened around 10% against the dollar since its peak, and market interventions to curb that slide have reduced China's foreign currency reserves from nearly $4 trillion to just over $3 trillion.
Beijing has introduced progressively stronger capital controls, restricting foreign exchange as well as overseas acquisitions. This helped rein in the foreign reserve slide for a time. But "selling pressure on the yuan has flared up again" of late, according to a Chinese bank.
A downgrade to China's sovereign debt rating did not help matters. Moody's Investors Service of the U.S. announced the cut Wednesday. There seems to have been some intervention in the currency market the following day, according to a foreign bank.
There was also concern that speculative yuan-selling could pick up again if the U.S. Federal Reserve were to raise interest rates at its meeting in June. Changing the reference rate calculation aims to head off that problem, scuttling hedge funds' plans well in advance.
The yuan strengthened to 6.85 against the dollar in trading on the Chinese mainland Friday afternoon as news of the coming adjustment spread, and reached 6.82 yuan to the dollar in offshore markets. The Chinese currency had approached 7 yuan to the dollar early this year.
Adding opaque new elements to how the yuan reference rate is computed could do some harm to the currency's global reputation, countering Beijing's efforts to spur the yuan's use around the world. Walking away from market liberalization does not play well in the international community, regardless of the domestic concerns behind that retreat.