Home >Opinion >Is China signalling a more free-floating yuan?
The reference rate for yuan was fixed 1.6% lower for Wednesday, after a 1.9% cut the previous day. Photo: Reuters
The reference rate for yuan was fixed 1.6% lower for Wednesday, after a 1.9% cut the previous day. Photo: Reuters

Is China signalling a more free-floating yuan?

PBoC hinted that the reference rate for yuan would be linked more closely to movements in the spot currency market

Mumbai: For the second day in a row, China fixed the reference rate for the yuan sharply below the previous day’s levels and also signalled that the reference rate would be linked more closely to movements in the spot currency market. The International Monetary Fund (IMF) welcomed the move saying that greater exchange rate flexibility is important for China.

The reference rate for yuan was fixed 1.6% lower for Wednesday, after a 1.9% cut the previous day. On Tuesday, the People’s Bank of China (PBoC) statement had suggested that the depreciation was a one-off adjustment.

In another set of questions answered on its website, PBoC said that the main reason for the lower reference rate is the previous day’s movement in the spot market.

“Due to the existence of intra-day fluctuation in FX market, if the closing rate of previous day deviates significantly from the central parity of that day, the central parity of the following day will deviate from that of the previous day accordingly," said the PBoC.

The central bank, however, added that there is no reason for a persistent depreciation in the yuan, keeping in mind domestic and international economic and financial conditions.

Under existing rules, the Chinese central bank announces a daily reference rate for its currency and then allows it trade in a band of +/- 2 percentage points around that band. By indicating that the reference rate itself would be more directly linked to the market rate, China appears to be signalling a move towards a more market determined rate.

While the central bank had said in Tuesday’s statement that the daily reference rate would align more closely with the previous day’s spot rate, market analysts were waiting to see how this will play out in reality.

While highlighting possible scenarios in a report on Tuesday, JPMorgan analysts had said that if PBoC sets the reference rate based on the previous day’s spot rate, then the yuan would become a freely floating currency. However, the central bank could also intervene in the spot market through dollar sales to ensure that the spot market does not deviate widely from the reference rate.

“The movement in the yuan spot and reference rates in the next few days are important to assess which of the two scenarios will play out," said the JPMorgan report.

If China does allow its currency to float more freely, it could partly be in response to IMF’s observations in its recent review of the special drawing rights (SDR) basket. In the review released last week, the IMF had said the central parity rate (the reference rate) is not an appropriate reference exchange rate to be used in SDR calculations due to discrepancies between the reference rate and the spot rate.

In a statement, the IMF welcomed the changes in China’s currency regime.

“The new mechanism for determining the central parity of the Renminbi announced by the PBoC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will depend on how the new mechanism is implemented in practice," said IMF in a statement on Tuesday night.

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