Re-thinking the Yuan

Liseth Galvis - 08 February 2018

In January 2018 the People’s Bank of China (PBOC) announced that it will remove the “counter cyclical factor” used to determine the midpoint reference rate for the Yuan (CNY) against the US Dollar. This means that market forces will play a greater role in determining the level of the USD/CNY. Its removal, only a year after this safety measure was implemented, shows a remarkable confidence in the ability of Yuan to hold its own. It follows a year where the Chinese currency appreciated by 6.3 per cent against the US Dollar (figure 1), an abrupt turnaround from the 7 per cent depreciation observed in 2016. 

While China’s capital account is tightly controlled, and likely to remain so, its desire for international status and recognition is clearly at odds with the perception of a perennially weakening currency. Since the POBC implemented bilateral currency swaps with central banks overseas in 2009, the Yuan has seen increased use abroad. SWIFT reported (2016) that the Yuan has been more widely adopted to settle transactions, as the fifth most popular currency for global payments. From October 2016, the Yuan was included in the Special Drawing Right (SDR) basket (a composite alternative reserve asset) of the International Monetary Fund with a higher weight (10.92 per cent) than either Sterling (8.09 per cent) or the Japanese Yen (8.33 per cent).

Figure 2 shows that Yuan appreciation against the basket has been much more gradual than against the depreciating US Dollar. Based on the RMB exchange rate index, the Yuan appreciated 2.85 per cent between May 2017 and January 2018. Another factor that has contributed to the Yuan appreciation is the decrease in capital outflows. According to the Natixis China Flow Tracker (figure 3), total capital outflows from China in 2017 amounted to US$408 bn. This represents a decrease of 54 per cent, compared to 2016 (US$884bn).

This reduction can be explained by the implementation of capital controls by the PBOC at the end of 2016, which included strict limits on large corporate investments with an impact on mergers and acquisitions. Since July 2017 banks and other financial institutions in China are required to report all domestic and overseas cash transactions of more than Y50,000, compared with Y200,000 previously. From the start of this year, the authorities have moved to cap overseas withdrawals by individuals using Chinese bank cards at RMB 100,000 per year.

The reassertion of tighter capital controls has allowed China to rebuild its foreign exchange reserves (now US$3161bn) and adds credibility to the Yuan as an international store of value. At the same time, it urges domestic exporters to become more competitive. Against a benign global economic backdrop, sudden changes in Chinese monetary policy are unlikely. A second year of moderate appreciation of the Yuan is a probable outcome.  

Figure 1: 

Data source: Thomson Reuters Datastream

Figure 2

Data source: CEIC

Figure 3

Source: Natixis

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