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PBoC introduces a ‘counter-cyclical’ factor in fixing of the renminbi

The renminbi has appreciated against the US dollar by more than 1% since late May, which was when the People’s Bank of China (PBoC) engineered a short-term interest-rate squeeze in the offshore renminbi (CNH) market.

The renminbi has appreciated against the US dollar by more than 1% since late May, which was when the People’s Bank of China (PBoC) engineered a short-term interest-rate squeeze in the offshore renminbi (CNH) market.

The market was confused by an official announcement (on 26 May) stating that the PBoC had introduced a 'counter-cyclical' factor in setting the renminbi’s daily fixing. This is seen as the major force driving the renminbi’s recent appreciation. The authorities have so far not given any explanation for the change in policy or how this counter-cyclical factor will work.

There are three parts to the renminbi fixing

  1. The Chinese renminbi/US dollar’s spot closing rate as of 4:30pm of the previous trading day.
  2. The average of the 24-hour daily changes in the USD against the currencies in the CFETS basket, the BIS onshore renminbi (CNY)  basket and the IMF SDR basket.
  3. A PBoC discretionary adjustment based on its judgement of demand and supply conditions in foreign exchange markets, risk appetite and international developments.

The introduction of the counter-cyclical factor essentially means, in my view, that the PBoC is increasing the weight of the third (discretionary) part of the fixing. The move is arguably a step back from making the renminbi’s exchange rate more market-driven.

PBoC seen acting to squash speculation and market swings...

For the Chinese authorities, the justification is that rising volatility of the renminbi exchange rate does not reflect economic fundamentals such as falling capital outflows, improving GDP growth and BoP flows. The PBoC considers that the foreign exchange market is overly prone to irrational exuberance. The counter-cyclical factor has been introduced to dampen the market’s 'herd instinct'.

However, the absence of any official explanation has led to speculation in the market about the intentions of policymakers and the newly found strength of the renminbi. A popular view is that the PBoC wanted to squash speculation on a depreciation of the renminbi. This was triggered by Moody’s downgrading of China’s sovereign debt rating, which spurred negative media coverage of China’s financial problems at a time when Beijing is endeavouring to fix them.

Indeed, the renminbi started rising right after Moody’s announcement on 24 May. Technically, easing capital outflows and the recent weakening of the US dollar have made it easier for the PBoC to intervene and show the speculators who is boss.

...or pressure from US rate rises?

Another plausible explanation is that the PBOC is seeking to preempt potential pressure on the renminbi from a rise in US interest rates. The PBoC followed the last US rate hike by raising some of its short-term interest rates. This led some players to conclude that the PBoC would shadow US rate hikes in the future.

I do not share this analysis. Chinese short-term interest rates and bond yields have risen, and the regulatory tightening since March this year has aggravated the liquidity pressures in the Chinese system. In the face of a fragile domestic economy the PBoC is unlikely to follow the Federal Reserve’s (the Fed) monetary policy.

If the PBoC is not planning to raise rates, it will have to counter market expectations that it would shadow the Fed’s interest-rate moves. So the move to strengthen the renminbi fixing by using the counter-cyclical factor can be seen as an effort to manage market sentiment ahead of the next Fed rate rise and build up some cushion against potential downward pressure on the renminbi.

Finally, there is a speculation that PBoC might be trying to signal a long-term shift in its foreign exchange policy towards a strong renminbi. A strong renminbi could be an effective deterrent to capital outflows and an enticement to capital inflows. President Xi Jinping’s 'Chinese Dream' ambition also argues for China pursuing a strong renminbi policy over the long-term.

Whatever the reasons, the PBoC has more control

It is unclear whether the latest vague policy statement about introducing the counter-cyclical factor that has pushed up the renminbi means that such a policy change is underway. It does, however, point to the fact that with a relatively closed capital account, the Chinese authorities have much more control over the renminbi than many market players have thought and it will be risky to be positioned against them. Contrary to market consensus, I think there is a fair chance for the renminbi to appreciate against the US dollar this year after last year's 8% depreciation.

Written on 12 June 2017

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