The potential significance of the widening the Chinese Yuan trading band limits.

Bloomberg News reported on March 17, 2014 that the Chinese government plans to double its yuan currency daily trading limits to 2.0 percent on either side of a daily reference central bank reference rate, from 1.0 percent. The band was last widened in April 2012 from 0.5 percent, and before that from 0.3 percent in May 2007.The move was announced by the People’s Bank of China (PBOC) in a March 15 statement, and it is an affirmation of recent comments made by the PBOC governor, Mr. Zhou Xiaochuan, where he announced on the side lines of last week’s National People’s Congress (NPC) meetings that broad measures are in place that will enable interest rates across the board to be liberalise in approximately two years. This is in line with the Chinese government’s intention to broaden the scope of offshore yuan trading, and as well as gradually adopt more pro-market oriented reforms.

Several market economists and strategists interviewed by Bloomberg News have expressed mixed reactions to the latest PBOC’s announcement, with some applauding the move as a gradual shift in the Chinese government approach in allowing greater market participation in yuan trading, while others have indicated that the PBOC could actually do more, including introducing meaningful reforms that will change the rule on setting the daily fixing. Some have called for the PBOC to allow the yuan to be pegged against a basket of currencies weighted by the importance of its trading partners. However, I believe this move could eventually expose some of the Chinese government’s foreign exchange movements, a sensitive issue that even the Monetary Authority of Singapore (MAS), which does not have a fractional banking reserve system like the United States, adopts a peg of the Singapore Dollar against a basket of currencies, and the exact composition and identities of the basket of currencies are not disclosed, although it is widely known that it is comprised of some of the city state’s largest trading partners including US Dollars, Euro, British Pounds, Japanese Yen, Chinese Yuan, among others. I do not see that the Chinese government will venture that far in disclosing the composition of those trading partners’ currencies, which could have various implications to the daily foreign exchange movements.

With the announcement of the latest moves to expand the yuan daily trading limit, coupled by the ongoing declines in the value of the yuan against the US Dollar over the course of past few weeks, it represents quite a significant shift in the Chinese government’s approach towards maintaining a close peg with the US Dollar. Several US government officials have persistently called for the Chinese government to remove its peg against the US Dollar, so as to make US exports more competitive against the yuan, but so far, there have not been many reforms that focus on liberalising the yuan trading. Despite the slow start to adopting more market reforms, several US officials, including Treasury Secretary, Mr. Jacob Lew, has come out to praise China’s announcement to widen the daily trading band, which will mark a significant move towards a gradual shift to more market oriented reforms.

In summary, with China’s overall economic growth is likely to slow down in 2014 despite the affirmation by the Chinese government that economic growth is targeted at 7.5 percent. The widening of the daily trading limit is a good move which can be improved by gradually removing the policy of daily fixing. Barring any additional near-term moves by the PBOC, investors will have to be prepared for more volatilities ahead in the trading of yuan, including corporates and banks holding on to yuan-denominated loans, but with the Chinese government still maintaining a close watch over yuan daily trading, the currency is unlikely to veer too far off course to beyond the 2.0 percent limit. They need to ensure that the yuan is seen as a stable currency in order to maintain its control over its monetary value, and not to create any disorderly moves that could expose the potential vulnerabilities of the currency.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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