Stability Should Be the Focus of Exchange Rate Policy

In a report on monetary policy imple-mentation in the third quarter of 2018， Chinas central bank made its latest statement on the renminbi exchange rate policy. According to the report， it will deepen market-oriented reform of the exchange rate and improve the managed floating exchange rate system based on market supply and demand and adjusted in accordance with the basket of major currencies. It will also enhance the two-way fl oating fl exibility of the renminbi exchange rate and strengthen prudential supervision to maintain its stability when necessary. It is hoped that this will maintain the exchange rate at a reasonable and balanced level across the board， with a view to stabilize the renminbi exchange rate in case of overshooting.

Chinas exchange rate regime is based on market supply and demand and is carefully managed. In the current market， overshooting may trigger sharp changes in market sentiment， which could exert severe negative impacts on the financial system and even the wider Chinese economy.

Since the exchange rate reform launched on August 11， 2015， market entities have become more rational toward the exchange rate and the markets negative expectation of depreciation has been eased along with the fluctuation of the renminbi exchange rate. However， it is clear that concerns surrounding the renminbi have not fully abated. Against the backdrop of the continuously strengthening U.S. dollar， Sino-U.S. trade frictions and downward pressure on Chinas economy， expectation of depreciation has rebounded prominently as the yuan approaches seven per dollar.

According to the latest data released by the State Administration of Foreign Exchange， Chinas banks saw the foreign exchange settlement deficit narrow by more than 80 percent in October month on month. The foreign exchange market showed balanced supply and demand overall. However， market sentiment still remains volatile and the closing price of the renminbi against the U.S. dollar on several trading days was below the central parity rate.

Many market participants believe that once the exchange rate falls below seven， a sharp adjustment in market sentiment may occur， triggering an overshoot of the foreign exchange market and causing irreversible impacts on the fi nancial system and economic fundamentals. Under current circumstances， it is necessary for the central bank to enhance macro prudential management in order to avoid severe consequences.

The bank has already adopted several targeted measures， including strengthening communication with the market and implementing policies to avert risks. Based on their judgment of market conditions， banks releasing the central parity rate of the yuan against the U.S. dollar have reintroduced countercyclical factors.

The central bank has twice issued bills worth 10 billion yuan （$1.4 billion）， launching interest rate bidding through the Central Moneymarkets Unit bond tendering platform of the Hong Kong Monetary Authority to adjust renminbi liquidity in the offshore market.

To stabilize the exchange rate does not necessarily mean stopping market-oriented reform of the exchange rate regime. The goal is the medium- and long-term stability of the renminbi exchange rate. In fact， pushing ahead with the market-oriented reform and allowing the exchange rate of the yuan to fluctuate with more flexibility can effectively ease the markets negative expectation of depreciation generated by exchange rate fl uctuations. Therefore， market entities need to keep a rational attitude toward the fluctuations and maintain a stable mentality to consolidate the foundation of long-term stability.