Widening the Band

By+Lan+Xinzhen

The floating band of the renminbis trading prices against the U.S. dollar in the inter-bank spot foreign exchange market was enlarged from 1 percent to 2 percent on March 17， marking a further step toward the marketization of the renminbi exchange rate formation mechanism.

Since the Peoples Bank of China （PBC）， the central bank， began to allow a floating exchange rate in 1994， this has been the fourth adjustment and the most radical one. The floating band of the renminbis trading prices was expanded from 0.3 percent in 1994 to 0.5 percent in 2007， and then to 1 percent in 2012. According to the PBC， the latest move makes up part of a progressive reform， and took into consideration the adaptability of all economic entities.

The expansion of the floating range reflected the central banks resolution to push forward the marketization of the pricing of financial factors， which was a key component of the financial reform this year， said Ding Zhijie， Dean of the School of Banking and Finance at the University of International Business and Economics.

Ding said that， since July 2005， the PBC has adhered to a managed floating regime in reference to a basket of currencies based on market supply and demand. However， the basket of currencies was not mentioned in the central banks announcement this time， indicating less administrative intervention.

During the Third Plenary Session of the 18th Communist Party of China Central Committee held last November， it was advocated that the market should play a decisive role in resource allocation. Given that the exchange rate is an important price in the market， the expansion of the floating range will increase the flexibility of the renminbi exchange rate， enhance the effectiveness of capital allocation， give full play to the market， and accelerate the transformation of the economic development model and economic restructuring.

As the PBC suggests， Chinas foreign exchange market has seen continued increase in transaction volume， a wider selection of transaction categories， and a stronger will for independent pricing. In this sense， the 2-percent loosening of the floating band is suited to the current status.

The renminbi exchange rate will most likely go up after a round of depreciation， argued Zong Liang， deputy head of the international finance institute of the Bank of China. But the regulator should properly encourage the public to shun expectations for a tendency of constant devaluation， which would undoubtedly deal a blow to macroeconomic and financial stability.endprint

In response to the voices favoring a root-and-branch renminbi liberalization， Lu Zhengwei， an economist from Industrial Bank， held that China would shift to such a mechanism when the time was ripe. If the renminbi exchange rate was completely loosened， Chinas financial system would take a heavy toll， said Lu.

More flexible

From the restart of the renminbi exchange rate reform in 2005， the yuan took on a unilateral appreciation tendency， which came to an end and began to move in the opposite direction in February 2014. On March 17， the day that the trading band was adjusted， the renminbi even depreciated by 279 base points. Some people suspected it was the adjustment that resulted in the devaluation， while others believed the fluctuations marked a new era for the renminbi featuring more floating room and less intervention.

According to documents from the PBC， the enlargement was designed to reinforce the two-way floating flexibility and had no direct links to the ups and downs of the renminbi exchange rate.

The PBC explained that its the supply and demand of foreign exchanges that decides changes in the renminbi exchange rate. Since the ratio of the current account surplus against the GDP fell to 2.1 percent in 2013， many felt the renminbi had lost the fuel for appreciation. Meanwhile， because financial risks are kept under control and foreign exchange reserve is sufficient， there are no grounds for a sharp depreciation.

Hence， as the marketization keeps progressing， two-way fluctuations of the ren-minbi will become normal in the future just like other major currencies around the globe. Yet， the central bank is prepared to make some necessary adjustments if things go off the track.

According to an analysis report released by JP Morgan， the band widening itself will have little impact on the economy， and the possible consequence could be used to stabilize the growth. The weak economic data imply that it is unlikely that renminbi appreciation and capital inflows will be seen after the band widening. If that happens， renminbi depreciation could support exports， and capital outflow will drain domestic liquidity and open the window for reserve requirement ratio cuts by the PBC.

“We do not think the renminbi is shifting toward a depreciation trend. In the near term， we expect the renminbi to remain stable，” said the report.

Although the band widening may increase the possibility of depreciation for the moment， in the long run， the renminbi will go through a cycle of small appreciations.endprint

Boosting exports

These days， all major currencies employ a floating exchange rate system， which propels exporters to face up to fluctuations in the exchange rate of domestic currency against foreign currencies. Its safe to say that the renminbi exchange rate is more stable in comparison with that of the developed world and other emerging economies. The United States， Europe and Japan adhere to a free floating regime， while other countries that practice a managed one see that their exchange rates are far more volatile than the renminbi.

Since the exchange rate reform in 2005， Chinese exporters have become increasingly accommodated to exchange rate fluctuations. The band widening， by and large， will urge enterprises and individuals to value exchange rate as an important factor affecting and facilitating resource allocation， as well as intensifying the resilience of the macroeconomy.

The change from unilateral appreciation to two-way fluctuations will please exporters and stimulate importers to actively deal with uncertainties.

China has set its foreign trade growth target at 7.5 percent for this year， lower than the 8-percent goal of 2013. Despite that， challenges still exist. According to statistics from the General Administration of Customs of China， the countrys exports totaled $114.1 billion in February， down 18.1 percent year on year， marking a re- cord low since September 2009. Thats because international purchasing power has not yet completely recovered from the global financial crisis and the renminbi appreciation in the past has squeezed many Chinese export-oriented companies out of business.

An analysis report from Shanghai-based Shenyin & Wanguo Securities， a leading brokerage company， says the inflow of hot money， to some extent， would be restrained. Since hot money always aims to exploit the margins between exchange rates and interest rates， the band widening will force speculators to take volatility into account and possibly withdraw from the Chinese market. When the renminbi exchange rate is heading toward stability or alternating between depreciation and appreciation， export companies will be unburdened of their pressures.

However， the widening will make it more difficult for export companies to decide when to settle accounts. Instead of making decisions based on the assumption of a rising yuan and a devaluing U.S. dollar， enterprises now have to consider the timing of settlement and hedging. Otherwise， the profits that have already come into their hands may be diminished.

The PBC believes the adjustment was not enough to shock enterprises and financial institutions， and would help them strengthen the awareness of mitigating risks with hedging tools.endprint