China Widens Currency Band, But Intervention Is Still Expected

The People’s Bank of China, the central bank, has widened the daily trading band of the renminbi from +/- 1% to +/- 2% effective 17 March. This means the currency will be allowed to appreciate or depreciate against the US dollar and other currencies as much as 2% either way.
Analysts had expected the move following the central bank’s guiding of the currency lower in recent days to signal to the market that the renminbi is not a one-way bet towards steady appreciation. That perception had resulted in strong financial inflows.
“The band widening is a strong signal that policymakers are moving towards more exchange rate flexibility over time,” reckoned the Royal Bank of Scotland in a report. “More flexibility is crucial for the overall process of monetary and exchange rate reform – China needs greater exchange rate flexibility before further opening up its capital account to financial flows.”
One US dollar bought RMB6.152 on 14 March, down 1.6% from the beginning of the year, noted the Wall Street Journal. “That is a drastic decline for a currency that gained 2.9% last year and has appreciated more than 30% since the re-evaluation in 2005, when China dropped the yuan's decadelong peg to the dollar.”
What does this mean for companies and their CFOs and treasurers? “We do not think much will change at the day to day level on China's FX market in the short term,” says RBS. “The PBoC will continue to set the fix – the centre of the now enlarged band – at the beginning of every business day.”
“Moreover, it will continue to heavily manage the spot rate. China has a structural surplus on the FX market of US$300-400 billion per year – from the current account surplus and net FDI – which, at least in our forecast, will not easily go away in the coming years on current trends.”
If there is more volatility in the currency rate, RBS believes that this initially will have to be “policy-induced” in large part.  However, in the long term, the bank expects the volatility to be more truly market-driven.
The recent depreciation has been fairly successful in making a point about two-way risk, and the band widening will further help making that point, say the RBS economists. But it involved extensive intervention, which increased the central bank’s foreign exchange reserves.
“Therefore, we would not be surprised to see some strengthening of the CNY vs. the USD this week, although it is hard to be sure,” the bank concludes. The long term trend is also appreciation, but with spikes and falls along the way as the central bank guards against perceptions of a one-way bet, which can complicate policy-making and financial reform.  



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