2005-07-22

How does the new RMB peg work?

Please tune in later as the understanding of how it works is still incomplete. As more data come in we should be able to understand the system better (brown colored = edited after the original blog is posted).
-- most recent update Aug 4th, 2005.

According to Oriental Daily in HK:
"根據官方公布,人行即時將人民幣匯價升值,由原來約八點三元人民幣兌每美元,調升至八點一一元人民幣兌每美元,升幅約為百分之二。人行並且改變與美元掛的做法,改為參考一籃子貨幣的匯率變化,對人民幣匯率進行調節和管理。美元兌人民幣交易的每日上下波幅區間定為千分之三,其他非美元貨幣兌人民幣的交易波動,亦維持在人行所定下的固定範圍。至此,市場一直期待的人民幣升值與匯改終於同時實現。
...關於人民幣改以一籃子貨幣的匯率波動為參考,人行指出參考一籃子不等於盯住一籃子,還需要將市場供求關係作為另一重要依據,藉此形成有管理的浮動匯率。人行在公布中完全避談一籃子貨幣組合中包括甚麼貨幣,及各貨幣之間的參考權數比重,似乎是要保持一籃子貨幣組合的神秘性質,方便其進行匯率管理。"

This is how I believe the basket peg works. (China's new system may have some twist in implmentation, to ensure continuity, which I will explain later)
  • There will be a basket of currency, maybe around a dozen, including USD, EUR, JPY, HKD, GBP, plus currency of China's other major trading partners.
  • USD will still occupy over 50% of the weight in the new basket, but its weight may be reduced gradually in future ("Cross the River Stone by Stone" (摸着石头过河) ) -- more likely 70%-80% for USD and HKD combined (THB was 88% effectively linked to USD in 1997)
  • Every now and then (maybe daily, hourly or in real time) a new central parity ("medium value" in the gap/band) will be recalculated. Then the trading range will be monitored and controlled at +/- 0.15% around this medium value for USD, with different ranges for other currencies (perhaps 0.5-1% for EUR and JPY). If necessary, PBC will intervene to contain the trading range to within the gap
  • Every evening the closing price will be announced, in theory this will be within range of the the gaps for each currency. PBC said it will use this closing price as the central parity for the next trading day.
  • The precise combination of the basket (or the formula) is not disclosed, as PBC retains the control to adjust or change the basket mix on extreme circumstances (PBC also stressed they only 'reference' a basket formula and they have the discretion to not follow strictly the formula -- see below for discussion)
  • Let's look at a simple example, by assuming the basket is 70% USD, 30% EUR.
  • On July 22 (as announced on July 21 evening), the rate is 1USD=8.11RMB and 1EUR=9.81Rmb (because 1EUR=1.21USD), to get 8.11RMB you need to give PBC USD0.70 and EUR0.30/1.21
  • During the day USD/RMB is allowed to trade at 8.11 +/- 0.012; EUR/RMB at 9.81, and maybe +/- 0.05 -- note the gap for EUR may be larger than 0.3% ("The daily trading price of the US dollar against the RMB in the inter-bank foreign exchange market will continue to be allowed to float within a band of of 0.3 percent around the central parity published by the People's Bank of China, while the trading prices of the non-US dollar currencies against the RMB will be allowed to move within a certain band announced by the People's Bank of China"), we observed from 7/22-8/3 that the EUR and JPY gap to be about 0.5%
  • Recalcuation: PBC will take the spot price of USD and EUR, e.g. if EUR/USD=1.19, then the new central parity for USD/RMB will become 8.11x70%+9.81*/1.19*30%=8.15, new EUR/RMB central parity = 8.15*1.19=9.70
  • The adjusted gap on July 22 will be (roughly) 0.3% from these magic numbers for USD, and maybe 0.5% for JPY and EUR
  • During day trade, PBC will defend the x-rate to the gap (e.g., +/- 0.15% for USD)
  • I would expect China to follow the formula rather strictly. (i.e. the mix of the basket, what spot price to use in the daily recalculation) The fact that they keep the basket content as a mystery (and said they will only "reference" the formula) is just a way to deter speculators away
  • Note that in a basket peg the recalculation is a totally independent concept from the 0.3% gap and one should not confused the two. e.g. the daily adjustment/change can be 3% away from yesterday if that is what the market says (e.g., if USD depreciates vs EUR by 7%, and USD weight is 70%(USD weight):30%(EUR/non USD). then the daily adjustment is 7%/70%x30%=3% so that the basket weighted average is unchanged.)
  • However, the basket content (weight and currency) and the width of each gap will be adjusted periodically. The fact that an adjustment has been done should be announced (Singapore announced the adjustment every 6 months, China is probably still trying to find what would be a suitable relaxation time)
  • People also talk about the "crawl". i.e. When the closing price is assymetrically drifted away from the central parity (because there is a gap), the central parity in the next trading day 'crawls' away from that of the previous day. e.g. if there is a general push for RMB to appreciate, PBC can choose to intervene on USD to keep it in a narrower gap while letting other currencies drift further away (but still within the gap).
  • PBC said "2. The People's Bank of China will announce the closing price of a foreign currency such as the US dollar traded against the RMB in the inter-bank foreign exchange market after the closing of the market on each working day, and will make it the central parity for the trading against the RMB on the following working day." Businessweek interprets this statement as "China says each day it will choose one currency from the basket to be the reference currency -- but it apparently won't say which one". (Note in the Chinese announcement it seems to imply the XR for all currencies would be published, literally it means "the closing price the USD and other foreign currencies").
  • Last note, it should be very straightforward to calculate the basket composition based on the spot rate and the daily announcement. But due to the gap at the anounced closng prices, the error will be about the size of the gaps. If there is indeed a systematic crawl, the regression analysis is made very difficult and even impossible
  • In theory, if there are 12 currencies in the basket, one only needs 12 days of data to solve the simultaneous equation of 12 variables (In fact, there are only 11 degrees of freedoms). i.e., provided we know which 12 currencies are used and the spot price is different enough over these 12 data points (linear independence)
  • In practice, one should use multi-variable regressional analysis
  • It is not difficult to guess what currencies are used (there are only 200 currencies in this world and only about 20 relevant one in this case, many are pegged (therefore, not linear independent) to some major currencies
  • Note the fact that each currency has a different gap means China will be able to influence the cross exchange rate of other currencies

Some additional information I obtained recently, which enabled me to update this post:

  • (Edited to add Jul/23) The above is how an ideal system works. However, there is the problem of continuity. The opening price (central parity) tomorrow may be significantly different from the closing price today. Today (7/22 Friday) PBC announced the central parity for Monday using the word "closing price"(人民币汇率交易收盘价). So it seems they are monitoring the basket central parity during the day, in real time (instead of at end of the trading day as described above). This way the closing price of the day is already within the gap of monitoring, but it is not neccessarily the new central parity. We can at best say the "closing price" is within gap (0.3% error) of the new central parity. It adds a lot more uncertainty when one wants to use regressional to reverse engineer the basket content, and deems speculation effort on this line impractical. -- we will have more insights as more data flow in.
  • (Edited to add Jul/27) Fang Xinghai's "Appreciation Has Its Limit" in WSJ July/27 A12 said (1) a periodic adjustment (of the peg and inside the basket are "critical feature of the new regime") (2) "0.3% against the dollar and ... by even more against the euro and yen" -- seems this is where the crawl mechanism is implemented

Below are the official announcement and the Q&A by PBC. A few points worth noting (english version here)

  • 人民币汇率改革必须坚持主动性、可控性和渐进性的原则
  • 3 principle for this (and future) reform in RMB forex: activeness/preemptiveness (we determine what/when/how ourselves); control (ability to withstand extreme volatitility); progressiveness ("cross the river stone by stone")
  • 中国人民银行将根据市场发育状况和经济金融形势,适时调整汇率浮动区间
  • PBC will adjust the 'region of float' based on market needs. The translation of "region of float" could be the medium value (central parity) announced every evening, it could also mean the 0.3% gap. Literally it translates more closely to the gap. => He Fan's comments that there may be another "baby step": widening the trading band from 0.3% to say 0.5% or 1% in future.
  • However, under this system, there is a limit on how large the gap is, otherwise if EUR/USD rate changes a lot during the trading day, people can exchange USD for EUR before converting into RMB (arbitrage)
  • 参考一篮子货币进行调节 ("The People's Bank of China will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation. The RMB exchange rate will be more flexible based on market condition with reference to a basket of currencies")
  • PBC said it will "Adjust next day's rate by referencing a basket of currency", it did not commit to strictly follow the formula. Although I believe they would still follow the formula very closely. Question is: Would a regular random departure from the formula does any good for PBC?

see also(in Chinese): http://finance.sina.com.cn/roll/20050721/1905220622.shtml

中国人民银行21日发布公告称,为建立和完善我国社会主义市场经济体制,充分发挥市场在资源配置中的基础性作用,建立健全以市场供求为基础的、有管理的浮动汇率制度,经国务院批准,现就完善人民币汇率形成机制改革有关事宜公告如下:
  一、自2005年7月21日起,我国开始实行以市场供求为基础、参考一篮子货币进行调节、有管理的浮动汇率制度。人民币汇率不再盯住单一美元,形成更富弹性的人民币汇率机制。
  二、中国人民银行于每个工作日闭市后公布当日银行间外汇市场美元等交易货币对人民币汇率的收盘价,作为下一个工作日该货币对人民币交易的中间价格。
  三、2005年7月21日19时,美元对人民币交易价格调整为1美元兑8.11元人民币,作为次日银行间外汇市场上外汇指定银行之间交易的中间价,外汇指定银行可自此时起调整对客户的挂牌汇价。
  四、现阶段,每日银行间外汇市场美元对人民币的交易价仍在人民银行公布的美元交易中间价上下千分之三的幅度内浮动,非美元货币对人民币的交易价在人民银行公布的该货币交易中间价上下一定幅度内浮动。
  中国人民银行将根据市场发育状况和经济金融形势,适时调整汇率浮动区间。同时,中国人民银行负责根据国内外经济金融形势,以市场供求为基础,参考篮子货币汇率变动,对人民币汇率进行管理和调节,维护人民币汇率的正常浮动,保持人民币汇率在合理、均衡水平上的基本稳定,促进国际收支基本平衡,维护宏观经济和金融市场的稳定。

PBC Q&A session: http://finance.sina.com.cn/g/20050721/20151822825.shtml

english version now available here
央行答问:为何完善人民币汇率形成机制改革

  中国人民银行21日宣布,经国务院批准,自2005年7月21日起,我国开始实行以市场供求为基础、参考一篮子货币进行调节、有管理的浮动汇率制度。

......,中国作为一个负责任的大国,主动收窄了人民币汇率浮动区间。随着亚洲金融危机的影响逐步减弱,近年来我国经济持续平稳较快发展,经济体制改革不断深化,金融领域改革取得了新的进展,外汇管制进一步放宽,外汇市场建设的深度和广度不断拓展,为完善人民币汇率形成机制创造了条件。
  问:为什么要进行完善人民币汇率形成机制改革?
  答:完善人民币汇率形成机制改革,是建立和完善社会主义市场经济体制、充分发挥市场在资源配置中的基础性作用的内在要求,也是深化经济金融体制改革、健全宏观调控体系的重要内容,符合党中央和国务院关于建立以市场为基础的有管理的浮动汇率制度、完善人民币汇率形成机制、保持人民币汇率在合理均衡水平上基本稳定的要求,符合我国的长远利益和根本利益,有利于贯彻落实科学发展观,对于促进经济社会全面、协调和可持续发展具有重要意义。
  推进人民币汇率形成机制改革,是缓解对外贸易不平衡、扩大内需以及提升企业国际竞争力、提高对外开放水平的需要。近年来,我国经常项目和资本项目双顺差持续扩大,加剧了国际收支失衡。2005年6月末,我国外汇储备达到7110亿美元。今年以来对外贸易顺差迅速扩大,贸易摩擦进一步加剧。适当调整人民币汇率水平,改革汇率形成机制,有利于贯彻以内需为主的经济可持续发展战略,优化资源配置;有利于增强货币政策的独立性,提高金融调控的主动性和有效性;有利于保持进出口基本平衡,改善贸易条件;有利于保持物价稳定,降低企业成本;有利于促使企业转变经营机制,增强自主创新能力,加快转变外贸增长方式,提高国际竞争力和抗风险能力;有利于优化利用外资结构,提高利用外资效果;有利于充分利用“两种资源”和“两个市场”,提高对外开放的水平。
  问:完善人民币汇率形成机制改革的主要目标和原则是什么?
  答:人民币汇率改革的总体目标是,建立健全以市场供求为基础的、有管理的浮动汇率体制,保持人民币汇率在合理、均衡水平上的基本稳定。
  人民币汇率改革必须坚持主动性、可控性和渐进性的原则。主动性,就是主要根据我国自身改革和发展的需要,决定汇率改革的方式、内容和时机。汇率改革要充分考虑对宏观经济稳定、经济增长和就业的影响。可控性,就是人民币汇率的变化要在宏观管理上能够控制得住,既要推进改革,又不能失去控制,避免出现金融市场动荡和经济大的波动。渐进性,就是根据市场变化,充分考虑各方面的承受能力,有步骤地推进改革。
  问:新的人民币汇率形成机制的内容和特点是什么?
  答:这次人民币汇率形成机制改革的内容是,人民币汇率不再盯住单一美元,而是按照我国对外经济发展的实际情况,选择若干种主要货币,赋予相应的权重,组成一个货币篮子。同时,根据国内外经济金融形势,以市场供求为基础,参考一篮子货币计算人民币多边汇率指数的变化,对人民币汇率进行管理和调节,维护人民币汇率在合理均衡水平上的基本稳定。参考一篮子表明外币之间的汇率变化会影响人民币汇率,但参考一篮子不等于盯住一篮子货币,它还需要将市场供求关系作为另一重要依据,据此形成有管理的浮动汇率。
  根据对汇率合理均衡水平的测算,人民币对美元即日升值2%,即1美元兑8.11元人民币。这一调整幅度主要是根据我国贸易顺差程度和结构调整的需要来确定的,同时也考虑了国内企业进行结构调整的适应能力。
  问:为什么选择目前的时机改革人民币汇率形成机制?
  答:中国政府在人民币汇率问题上始终坚持独立自主、高度负责的态度,坚持从我国的根本利益和经济社会发展的现实出发,选择适合我国国情的汇率制度和汇率政策。当前,是完善人民币汇率形成机制改革的较好时机。目前,我国外汇管理逐步放宽,外汇市场建设不断加强,市场工具逐步推广,各项金融改革已经取得了实质性进展;宏观调控成效显著,国民经济继续保持平稳较快增长势头;世界经济运行平稳,美元利率稳步上升。这些都为人民币汇率形成机制改革创造了有利条件,奠定了坚实的基础,可以达到预期的改革效果。
  问:各方面应如何应对完善人民币汇率形成机制改革带来的挑战?
  答:汇率形成机制改革在短期内会对经济增长和就业产生一定影响。但总体上利大于弊。我们将积极稳妥地推进人民币汇率形成机制改革,积极创造有利条件,引导企业加强结构调整,平稳度过改革调整期。银行和外汇管理部门要进一步改进金融服务,加强外汇管理,为企业发展提供强有力的支持。企业要积极推进结构调整步伐,转换经营机制,提高适应汇率浮动和应对汇率变动的能力。
  问:此项改革推出后,人民币汇率会不会出现大幅波动?
  答:人民币汇率改革的总体目标是,建立健全以市场供求为基础的、有管理的浮动汇率体制,保持人民币汇率在合理、均衡水平上的基本稳定。人民币汇率大幅波动,对我国经济金融稳定会造成较大的冲击,不符合我国的根本利益。完善人民币汇率形成机制改革决不会出现这种情况。首先,汇率形成机制改革后,人民币不再盯住任何一种单一货币,而是以市场供求为基础,参考一篮子汇率进行调节。国际市场主要货币汇率的相互变动,客观上减少了人民币汇率的波动性。其次,随着汇率等经济杠杆在资源配置中的基础性作用增强,外汇供求关系进一步理顺,国际收支调节机制逐步建立健全,国际收支会趋于基本平衡,为人民币汇率稳定奠定了坚实的经济基础。第三,我国将积极协调好宏观经济政策,稳步推进各项改革,为人民币汇率稳定提供良好的政策环境。最后,人民银行将努力提高调控水平,改进外汇管理,保持人民币汇率在合理、均衡水平上的基本稳定

4 comments:

Sun Bin said...

http://intl.econ.cuhk.edu.hk/exchange_rate_regime/index.php?cid=3

compare to Singapore's board. the difference is actually quite small.

both have a black box of undisclosed basket.

RMB has a narrow band of 0.3%, SGD has an undisclosed band

SQD is freely floated, central bank may intervene is it is out of bound. RMB rate is announced daily.

Sun Bin said...

Some people said it will be a 'crawl' of max 0.3% (in fact 0.15%) per day, if the basket recalculations requires a change larger that that number. It makes no sense. The central parity will then be predictable and it will attract more speculators. PBC will lose tons of RMB.

The central parity should only be dictated by market force during the past 24 hours. i.e. the relative shift within the basket.

Sun Bin said...


Stephen L Jen of Morgan Stanley said,

"The basket is much more important than the revaluation. By adopting a basket reference framework, the determinants of USD/RMB are no longer the Chinese economic fundamentals, but other currencies in the basket. Because this is a basket reference rate, USD/RMB can go either higher or lower, depending on the underlying anchor currencies. (If EUR/USD sells off, it is possible USD/RMB trades higher than the original parity of 8.28!) The basket is likely to be heavily dominated by the USD. Using China’s trade weights, normalized, a five currency basket would have the following weights: USD (27%), JPY (31%), HKD (24%), EUR (15%), and GBP (4%). The hard dollar pegs (USD and HKD) account for close to 50% of the basket. If you consider the JPY as a soft USD peg, the weight on the dollar could be as high as 80%. This means USD/RMB will still be very ‘docile’, with the index being ‘sticky’ relative to the USD."

-- that agrees with my interpretation of the basket peg.

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