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Renminbi rule change tracks capital flight worries

China’s central bank will change the way it guides the renminbi exchange rate, a move designed to enhance the government’s ability to prevent renminbi depreciation at a time when authorities are still concerned about capital flight.

The People’s Bank of China permits the US dollar’s value against the renminbi to fluctuate by 2 per cent above or below a so-called “central parity rate” published each morning, also known as the midpoint or fixing. The midpoint is ostensibly formulated by compiling quotes from a group of dealer banks, but the price is understood to be largely determined by the central bank. 

Under the revised formula announced on Friday, dealers will incorporate a “counter-cyclical adjustment factor” in their quotes, according to a statement on the website of the China Foreign Exchange Trading System, an industry body controlled by the PBoC.

“It’s easy for the market to be influenced by irrational expectations and spurred by inertia . . . magnifying the risk of over-correction of the market exchange rate,” CFETS said in the statement. “The main motivation is to hedge appropriately against the pro-cyclical fluctuation in market sentiment and alleviate the potential for ‘herd behaviour’ in the foreign exchange market.”

In August 2015, the PBoC announced a change to the way it would formulate the midpoint, saying that the fixing would henceforth track on the previous day’s closing price the spot market. In December 2015, it modified the formula, declaring that midpoint would also reflect changes in the renminbi’s value against a broad basket of global currencies. 

CFETS noted on Friday that the US dollar has depreciated substantially in recent months, causing both variables in the fixing formula to push the midpoint weaker. The new counter-cyclical variable will prevent excessive one-way movement in such periods, the statement said. 

In recent weeks, analysts had observed that the daily midpoint had begun to diverge from where their models predicted it should be based on the PBoC’s previously stated methodology. 

“In general, this is designed to prepare some room to manoeuvre for future policy and a policy tool,” said Zhang Yu, head of overseas research at Minsheng Securities in Beijing. 

The renminbi weakened 6.5 per cent against the US dollar last year, its worst year ever, amid an unprecedented wave of capital outflows. But late last year, China tightened capital controls to curb downward pressure on the currency. That effort has largely succeeded, with the renminbi appreciating 1.2 per cent in 2017. 

China’s foreign exchange reserves have also risen for three straight months, a sign that renminbi stability is not primarily due to the PBoC intervening in the market to prop up the currency. 

It’s unclear if the change will have a bearing on the market. Currency traders have said that the influence of the daily fix has significantly decreased since the August 2015 policy change. 

Rather than the fix, it is active PBoC intervention in the market through buying and selling dollars that most strongly influences the renminbi exchange rate. The PBoC sold a net $280bn last year but activity has fallen to virtually zero in recent months, according to FT estimates based on official data.

Additional reporting by Nan Ma

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