Central bank's move to cool hot money

Wider range for yuan's fluctuation against the US dollar will deter destabilizing speculation

From March 17, the yuan's exchange rate fluctuation against the US dollar was expanded from 1 percent to 2 percent above or below the daily midpoint the central bank sets in the interbank spot foreign exchange market.

This will enhance the floating flexibility of the yuan and improve the efficiency of capital allocation, facilitating economic restructuring and strengthening the role of the market in allocating resources, and will not lead to a sharp depreciation, because of the improving balance of payments and foreign exchange deposits, the People's Bank of China said.

The move is the third time the central bank has acted to widen the yuan's daily trading range since 2005, when China launched reform of the currency's exchange rate regime.

To change the one-way appreciation momentum the yuan had maintained since 2005, the central bank decided on May 21, 2007 to expand the range of its daily fluctuations against the dollar from 0.3 percent to 0.5 percent in the interbank spot foreign exchange market. However, such a slight range adjustment failed to change the yuan's one-way appreciation trend. On April 16, 2012, the central bank decided to widen the range once again to 1 percent. The yuan generally maintained a rising trend in its value for more than one year following the move, but its two-way fluctuations within the allowed range also became more obvious.

The yuan had already changed its one-way appreciation and showed signs of considerable depreciation in the months prior to the central bank's announcement. Especially since the start of this year, the yuan's middle rate against the dollar had fallen by a total of 356 basis points, or 0.58 percent. In the spot foreign exchange market, which usually reflects market tendency more accurately, the yuan has depreciated by 1.65 percent over the past months. The recent sizeable depreciation of the currency is in sharp contrast with a rise of more than 3 percent in its value last year. It is hoped the bigger and more frequent exchange rate fluctuations within the new range will stop speculators betting on a one-way appreciation of the yuan.

It should come as no surprise that China's central bank could be intervening in a bid to fend off profiteering "hot money". The yuan's long-time one-way appreciation has created an ideal and no-risk destination for speculation, and China's monetary authorities should not have waited nearly nine years before forcibly intervening to stop the yuan's one-way appreciation, as the endless multi-channel inflow of overseas speculative capital in recent years has had a negative effect on the normal operation of China's economy.

The latest 2 percent range does not mean China has set up a fully marketized exchange rate formation for its currency. The increase of 1 percent embodies the "active, controllable and gradual" principle China's central bank has adopted in its push for the reform of the yuan's exchange rate formation mechanism. As a central bank spokesman put it, the latest extending of the range may mean some short-term pain for companies as they deal with more market risks, but it will increase their competitiveness in the long run. The central bank's move had been signaled prior to it being made, and the recent drastic depreciation of the yuan reflects a high degree of market sensitivity toward the move.

Despite such an expanded fluctuation range, China's central bank still imposes more limitations on the range of the yuan's daily trading against the dollar than against other foreign currencies. Currently, a 3 percent rise or fall is allowed for the yuan's daily exchange rate fluctuations against the euro, the pound, the Japanese yen and the Hong Kong dollar while a 5 percent range is allowed for the yuan's fluctuation against the Russian ruble and the Malaysian ringgit.

The harsher restrictions on the yuan's daily fluctuations against the dollar, the major currency of China's foreign reserves, are to prevent any large fluctuations having an excessive influence on the Chinese economy.

The central bank will watch and analyze the effect of the new range. During this period, the central authorities will be unlikely to exercise market interventions into the yuan's foreign exchange market and there is not much possibility for either one-way appreciation or depreciation of the yuan. Such two-way exchange rate fluctuations of the yuan will bring new tests to domestic exporters, but they need to adjust and deal with a more market-based exchange rate.

The central bank will continue to push for further liberalization of the yuan's exchange rate and will diversify the foreign exchange holdings to hedge against risks as it builds a market-guided and properly regulated floating exchange system.

The author is a Shanghai-based economics analyst. The views do not necessarily reflect those of China Daily.

(China Daily Africa Weekly 03/21/2014 page13)