New currency fix plan proposed for Chinese Yuan

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Feb 3, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Mumbai) - Some analysts have called for a new currency fix plan according to which China is to let the yuan fluctuate easily against a basket of currencies within a trading band. The trading band be 4 per cent to 15 per cent, meaning the range of fluctuation could be as narrow as 4 per cent and as wide as 15 per cent. The central bank would intervene only when the currency fluctuates outside the band. This plan could act as China’s safeguard in the wake of the changes introduced in its currency policy which led to huge outflow of $500 billion foreign reserves in the recent past creating capital crunch in the system. This plan is similar to one adopted by Singapore.

    The current system in place allows yuan to trade 2 percent above or below a reference rate versus the dollar. The reference rate is set by the PBoC and concentrates attention only on the on the dollar-yuan exchange rate. Also, given the lack of transparency investors find it difficult to understand how exactly the reference rate is decided upon and they are compelled to doubt the intention of the policy makers. Tamim Bayoumi, a senior fellow at Peterson Institute for International Economics and an economist at the IMF via Bloomberg “They are sort of stuck, I don’t think the market knows what exactly the policy is”.

    More importantly this new plan will be targeting more currencies and a wider band and thus will empower market forces to have more say in determining the exchange rates. The clarity in process will help China save its foreign reserves and also eventually shift focus of the investors away from the US dollar.

    Ever since Chinese policy makers introduced changes to the currency system to make it more flexible they have been trying to bring about stability in its currency market. Though policy makers have reiterated time and again that they intend to keep the exchange rate stable against a basket of other currencies even if it falls against the dollar, investors have not been convinced. Investors have been left feeling jittery particularly after yuan’s 5.6 percent slide versus the dollar over the past six months raised speculation of further devaluation. The central bank was almost forced to dig into its foreign reserves and tighten capital controls to support the yuan.

    According Yu Yongding, a former academic member of the PBOC’s monetary policy committee the new plan is unsustainable as it make way for the central bank to completely deplete its $3.3 trillion in reserves shortly. He feels that the PBoC should aim at an adjustable reference rate and a trading band of 7.5 percent or even 15 percent.

    China Foreign Exchange Trade System, a central bank unit sated on Monday that policy makers may introduce further reforms in its currency system. The government may likely opt to raise the “flexibility” of the yuan against a basket. analysts at Credit Suisse Group AG feel that Monday’s statement is an indication on “how the government hopes to manage the yuan”. Some analysts are however not too confident about new system. Qi Gao, a Hong Kong-based strategist at Scotiabank said via Bloomberg that “Targeting the basket is difficult because the yuan’s movement in itself could feed into the fluctuations of a broad range of exchange rates, creating the risk of a depreciation spiral”
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