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Home / Business / How the PBOC controls the yuan (RMB) in the middle of the trade war

How the PBOC controls the yuan (RMB) in the middle of the trade war



A bank employee counts US currency and Chinese banknotes in a bank in Nantong, Jiangsu Province, China.

Xu Jinbai | Visual China Group | Getty Images

China's yuan is being closely monitored as the economy slows, and Beijing remains locked in a trade war with the United States that has raged around global markets.

The land yuan fell to levels not seen since February 2008 on Monday, and the offshore yuan fell to its weakest since it began trading in the international market around 201

0.

The recent escalation in trading tensions left analysts and investors wondering how much further Beijing would allow the currency to weaken.

Here's a look at how China controls the yuan, also known as yuan.

One currency, two exchange rates

Unlike other major currencies such as the US dollar or the Japanese yen, which has a free floating exchange rate, China maintains strict control of the yuan's interest rate on the mainland.

Every morning, the People's Bank of China (PBOC) sets a so-called daily midpoint fixation, based on the yuan's previous day's closing level and quotes taken from inter-bank dealers. The central bank also manages China's complicated monetary policy.

The currency is allowed to trade within a narrow band of 2% above or below today's mid-point exchange rate. If it deviates too far, according to some market watchers, the Chinese central bank steps in to buy or sell the yuan, putting a lid on daily volatility. This exchange rate is known as the Yuan on land, or CNY.

The PBOC, which is heavily influenced by the central board, sets the daily centerpiece to provide direction to the market and manage the currency. The tightly controlled yuan on land has depreciated by about 4% against the dollar so far this month.

The yuan also trades outside the mainland, mostly in Hong Kong, but also in Singapore, London and New York. [19659002] Currency is known as the offshore yuan, or CNH, and is not as tightly controlled as the yuan on land. Supply and demand in the market affect the exchange rate of the offshore yuan, but the volume of sales is relatively smaller.

How the PBOC affects the yuan offshore

The central bank wants to keep the spread between onshore and offshore yuan narrow since they are technically the same currency, according to experts.

They say that if the offshore exchange rate deviates too far from the onshore figure, the central bank will intervene to curb volatility and support the currency using the huge foreign exchange reserves, which were more than $ 3 trillion as of July. PBOC is also dependent on state-owned banks entering the offshore market and exchanging dollars for the yuan.

To prevent the offshore yuan from weakening too quickly, the Chinese central bank is also issuing short-term yuan-denominated bills in Hong Kong that are mainly to scale up liquidity from the market and increase borrowing costs for the yuan, making it more expensive for people to short down the yuan.

If traders try to short the yuan, they predict that its value will weaken against another currency in the future. One way to do that is to borrow in yuan and pay back at a discount as the value of the currency declines.

Is there a new closely monitored country level?

China allowed the currency to weaken past a psychologically important level of 7 against the dollar in early August for the first time since the global financial crisis of 2008. It prompted the US Treasury to designate Beijing as its currency manipulator. Following this, the PBOC set the yuan midpoint fixation at a level beyond 7 for the first time in 11 years on August 8.

The CFETS RMB Index – which measures the yuan against a basket of its peers – also fell below a closely monitored level of 92, which it had maintained for more than two years, told Tommy Xie, head of the Great China the research at OCBC Bank, to CNBC.

He explained that the market is still trying to reach an agreement on the next important level for the country's currency, and some have suggested that it may be 7.20 yuan per dollar.

A Hong Kong-based banker told CNBC that the next closely monitored level could be around 7.25 and depending on the evolution of the US-China trade war, it could weaken even further if charges are further increased.

A weaker currency makes Chinese exports cheaper and more competitive in the international markets, and could potentially counteract some of the impact from the tariffs.

Still there is n It is likely that Beijing will weaken the yuan too quickly.

This is because there are fears that a rapidly depreciating yuan could lead to significant outflows of capital, with investors moving assets out of a country due to perceived instability and preventing wealth from weakening. There is also concern that credit markets are freezing and national economic conditions are tightening, as it did after the yuan fell 2% in 2015. It has taken China years to stabilize capital outflows ever since.

Internationalization efforts

On the economic front, making the yuan more international is high priority for China, according to some experts.

China increased its efforts to internationalize the currency after the global financial crisis when Beijing created the so-called dim sum bond market – or yuan-denominated bonds issued outside the mainland – and allowed cross-border trade in yuan.

Beijing, in turn, will have more price power for important commodities, such as oil, and wealth prices, such as gold. It wants the yuan to become a top reserve currency, much like the US dollar.

The dollar status of the global financial market allows the United States to borrow with impunity without dampening investor sentiment on US assets, the Hong Kong-based banker explained. Should the yuan become a popular reserve currency, it could allow China to issue more debt to better manage its domestic needs.

However, China is still unwilling to mitigate the fears that there will be massive outflows of capital for many Chinese investors to move their money out of the country and into the international market.

The yuan joined the International Monetary Fund's basket of reserve currencies in 2016. China continues to track its value against other currencies in the RMB index.

But with a US-China trade agreement looking more and more uncertain, the yuan's dollar-to-dollar ratio remains closely followed by investors and economists.

– Reuters contributed to this report


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