Market should have more say in yuan rate

By Huang Jianhui and Ying Xiwen Source:Global Times Published: 2018/2/15 11:07:00

Since June 2017, several days after China's central bank announced it would introduce a countercyclical adjustment factor in calculation of the yuan's central parity rate, the Chinese currency reversed a nearly two-year depreciation against the US dollar. There were six main reasons for the yuan's strength. 

First, China's economy remained steady with year-on-year GDP growth of 6.9 percent in 2017, significantly better than the expectations of early last year. The IMF and the World Bank have raised their GDP forecasts for China.

Second, inflation remained steady. The CPI for 2017 increased about 1.6 percent, helping to ensure the yuan's purchasing power and provide fundamental support for the long-term exchange rate.

Third, M2 growth hit a record low last year. The M2 to GDP ratio began to decline after hitting a 208 percent high in 2016, falling to 202 percent at end-2017. Amid China's deleveraging effort, it was the first improvement in the problem of excess money supply.

Fourth, China's balance of payments for the first three quarters of 2017 showed that the "double surplus" in its current and capital accounts had returned, indicating that capital outflows had been reversed.

Fifth, China designated risk prevention as a priority at the 19th National Congress of the Communist Party of China and the Central Economic Work Conference. The strengthening and consolidation of the financial industry will help reduce systemic risk. 

Sixth, after experiencing sustained devaluation, expectations for further weakness in the yuan dissipated, and the market now expects two-way fluctuations.

The eight-month rise of the yuan contributed to the market's recognition of the yuan exchange rate in three ways. First, the anchor of the yuan was successfully shifted from the US dollar to a basket of currencies, and the volatility of the yuan against the US dollar further increased. As the US dollar fluctuates, the exchange rate of the yuan against the US dollar will inevitably show wide two-way fluctuation.

Second, exchange rate speculation is not the best choice for businesses or individuals. Chinese residents can buy foreign exchange depending on their actual need such as overseas travel or study abroad. Companies should focus on running their businesses while using hedging methods to avoid exchange rate fluctuations, rather than profit from them.

Third, credible expectations are more valuable than money. The central bank's credibility is far more useful than expanding foreign exchange reserves.

Recognition of these points is of great significance to the exchange rate reform of the yuan. First, the market has seen the flexibility of two-way fluctuations. Without this understanding, it wouldn't be easy for yuan exchange reform to make significant progress. Second, onshore market participants have become more mature, which provides a good basis for market diversification. Third, regulators have announced diverse measures, offering more confidence in further reform.

In the future, the best option will be to improve the mechanism, which should include gradually easing foreign exchange controls, promoting the development of yuan cross-border business, speeding up the yuan's internationalization and improving the exchange rate formation mechanism. 

The idea is to use the power of the market to make the exchange rate reach equilibrium. The next-best option would be to guide expectations and further strengthen market communications. Direct intervention in the market should be the last choice. 

The growth of foreign exchange reserves will affect the independence of monetary policy. But direct intervention is not conducive to the reform of the yuan exchange rate formation mechanism.

Recently, the yuan has been continuously appreciating. This rise has the potential to hurt exporters. It is also not conducive to the formation of two-way fluctuation expectations and it builds up more pressure for future depreciation. 

Regulators should improve the yuan exchange rate market mechanism, reasonably guide expectations and prevent the yuan from returning to the track of unilateral appreciation.

Huang Jianhui is head of China Minsheng Bank Research Institute, and Ying Xiwen is the director assistant of the Regional Economic Development Research Institute of China Minsheng Bank Research Institute.


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