jueves, 11 de febrero de 2016

jueves, febrero 11, 2016

How China devalued the yuan for the first time in two decades, and why it matters

What has the People's Bank of China done to change how the currency's daily reference rate is set?

By Peter Spence, Economics Correspondent


China’s shock currency adjustment earlier this month caught many in the financial markets off-guard.
 
It decided to devalue the yuan for the first time since 1994, shaving close to 2pc off its value on August 11.
 
The yuan - also known as the renminbi - is pegged against the US dollar by Beijing authorities, an arrangement they recently decided to shake up.
 
          
      China has changed how the yuan's value is set

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Who decides what the yuan is worth?


The People’s Bank of China (PBoC) implemented a new methodology for fixing the currency on August 11, affecting how the the "reference rate" is set.

That reference rate - or fixing rate - is the official exchange rate at which the PBoC wants the US dollar to trade against the yuan. The yuan is allowed to trade within a 2pc range either side of that reference rate, which is announced to the market at 9.15am in Shanghai every day.

The headquarters of the Peoples Bank of China (PBOC) in Beijing, China        The People's Bank of China in Beijing  Photo: EPA


This contrasts with a free-floating currency, like the pound or the euro. The value of those currencies is determined entirely by supply and demand, and how traders expect those things to vary in future.

The PBoC refers to the yuan regime as a “managed floating exchange rate regime”, but the word “managed” does a lot of the work in that description. Economists believe that if the yuan was set free, it could plunge by as much as 10pc against the dollar, or perhaps by as much as 30pc.
 
 
 

 

How is the yuan's value controlled?


The PBoC ensures that the yuan trades within its range by buying or selling dollars in order to steer the yuan's value.

If the PBoC creates more yuan and buys dollars, the yuan's value will fall. It’s not a difficult job for a central bank to depreciate its own currency: just create more and the currency will be worth less.

There are no limits on how much currency a central bank can create, although the distortions that arise during the process create may at some point outweigh the benefits.

Conversely, if the PBoC uses its dollar reserves to buy yuan, then the yuan's value will rise. This is slightly trickier; foreign currency reserves are finite. But China’s reserves are massive, and no-one fears that they’re about to run out.

As the yuan is currently seen as overvalued, it’s this latter kind of intervention we've seen more recently, ensuring that the currency has appreciated.

 

What’s changed about how the yuan is valued?


The process for setting the "reference rate" is now more reflective of "foreign exchange demand and supply", the PBoC said as it introduced its new system.

It's the first time the central bank has changed how the yuan is valued in about a decade.

The production of the new reference rate is now based more closely on where the yuan stopped trading the previous day, the “close” price of the currency - where it traded within the 2pc band around the reference rate.

As the new fixing methodology was implemented, the yuan slid by 1.9pc against the dollar, its biggest one-day fall since 1994, bringing it into line with the previous day’s close.

Capital Economics has argued that the adjustment to the yuan's value is a result of this mechanical change, and not a push to boost the economy, or to win favour with the International Monetary Fund.

 

What will happen next?

The market still thinks the yuan is overvalued, and with a new fixing regime in play, they’re liable to keep testing it for some time.

But the PBoC has now made clear that it’s willing to fight back to stabilise the currency as it sees fit.

Kit Juckes, of Societe Generale, said: "The PBoC has managed to kill off the notion that the new currency regime in China will allow the renminbi to weaken by 2pc on a daily basis."

100 yuan banknotes    The yuan may now begin to stabilise after its recent turbulence  Photo: ALAMY


The central bank has dismissed claims that it is attempting to engineer a 10pc depreciation against the dollar as "groundless".

Yi Gang, deputy governor of the central bank, said it stood ready to step in if volatility became "excessive" and the market started "behaving like a herd of sheep".

"Trust the market, respect the market, fear the market, and follow the market," he told a press conference.

Amy Yuan Zhuang, of Nordea, said that the PBoC's next policy move - whenever that comes - might be to widen the band in which the yuan is allowed to trade.

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