RMB peg mechanism updated

See this previous thread. It has been revised. See also updates on the basket content in this new post.

A few adjustments

  • Gap different for each currency, as observed in the past week, EUR and JPY has a gap of at least 0.5%
  • Central parity is based on the closing price of the previous trading day. Since these are just some numbers within the gap of the previous central parity, depending on how the market interacts with the intervention. This would probably be the reason for a crawl, without adjusting the basket content
  • I revised my understanding on the crawl, but the explanation is still incomplete -- I need some more work in analyzing the numbers
  • So far PBC has been keeping a tight hand on USD/RMB, while leaving EUR and JPY wandering further away from the central parity. Such maneuver might impact the cross rate in the international markets

PBC announced that the gap (right click to download pdf report in Chinese) will be "adjusted in appropriate time according to changes in market condition". Many previously said points were re-iterated, such as the central parity will remain fixed, but the mechanism will go through a change in "gradualism" (widening gap is one of them). - see English re-cap here.

Please click into the comment field for more recent updates


Sun Bin said...

according to SingTao Daily (HK)

Zhou Xiaochuan said,
"Basket's major components are USD, EUR, JPY and KRW, other currencies playing minor roles include SQD, GBP, Russia, Malaysia/etc.

Sun Bin said...

"etc" includes AUD, CAD, THB.

here is the english version
RMB basket content

Sun Bin said...

Ming Po has a better coverage. It said the logics of choosing these currencies are based on trade-weight.

It also talk about the basket as a means to reflect the 'goods trade' and "SERVICE trade"

Zhou is quotes "to put it simply, it is based on the combines consideration of our foreign trade, foreign debt (interest payment), FDI (and divident repatriation)......when these major partners as defined above are given the corresponding weight inside the basket"

Sun Bin said...

Official speech now available at PBC's website (Chinese)

current account is basis for determining weight
1 good trade (import, export)
2 service trade
3 FDI and related dividends (also Lenovo/CNOOC's investment overseas)
4 current transfer (e.g. private fund movement, overseas chinese sending to relatives)

for all the countries with volume over $5BN/year

Sun Bin said...

Zhou, "作为人民币汇率调节的一个参考,在篮子货币的选取以及权重的确定时主要遵循的基本原则是:考虑我国国际收支经常项目的主要交易国家、地区及其货币。大家知道,经常项目包括四项内容:商品贸易、服务贸易、收益(利息、分红等)及经常转移(华侨汇款等)。用通俗一点的话来讲,是综合考虑在我国对外贸易、外债(如付息)、外商直接投资(如分红)等外经贸活动中占较大比重的主要国家、地区的货币,组成一个货币篮子,并分别赋予其在篮子中相应的权重。



Sun Bin said...

english version from PBC

Regarding the reform of the RMB exchange rate regime, I would like to elaborate a little bit about the contents of the basket of currencies.

As you all know, with authorization of the State Council, on July 21, 2005 China moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. The RMB will no longer be pegged to the US dollar. Instead, the RMB exchange rate will be determined based on a basket of certain major currencies with assigned weights selected in line with the real situation of China's external sector development. At the same time, proper measures could be taken to manage and adjust the RMB exchange rate based on market supply and demand while considering the changes of the basket of currencies, so as to maintain the RMB exchange rate basically stable at an adaptive and equilibrium level. In this sense, it is quite natural that people are increasingly concerned about how the composition of the basket currencies is determined. To enhance public understanding of China's exchange rate policy, I would like to make the following clarifications regarding the determination of the basket currencies.

As a reference for the floating of the RMB exchange rate, the selection of the basket currencies and the determination of the weights assigned to these currencies must abide by a fundamental principle which is to give due considerations to the countries standing as China's trading counterparts in current account transactions and their national currencies. As you all know, there are four items under current account, namely, trade in goods, trade in services, income (including interest income and dividend income) and current transfers (such as remittance of overseas Chinese). To put it more simply, the basket should be composed of currencies of the countries to which China has a prominent exposure in terms of foreign trade, external debt (interest repayment) and foreign direct investment (dividend). And the weights respectively assigned to these currencies should also consist with the proportional importance of these countries in China's external sector.

-- Shares of trade in goods and services should be the fundamental considerations in the selection of the basket currencies and the weights assigned to the currencies in the basket.

Current account is a major component of China's balance of payments, whereas trade in goods and services is the predominant item of current account. The current situation in China shows that trade in goods and services dominates current account balance. Therefore, the shares of trade are the major considerations in the determination of the currency components of the basket. China's major trading partners are the United States, the Euro land, Japan, Korea, etc., and naturally, US dollar, euro, Japanese yen and Korean won become major currencies of the basket. In addition, China also trades significantly with Singapore, UK, Malaysia, Russia, Australia, Thailand, and Canada, currencies of these countries are also important in determining China's RMB exchange rate. Generally speaking, annual bilateral trade volume in excess of US$10 billion is not negligible in weight assignment, whereas that exceeding US$5 billion should also be considered as a significant factor in currency weight deliberation. When you look at currencies used in trade settlement, although some countries and regions prefer US dollar as the currency for trade settlement with China, this situation is changing gradually and trade settlement in local currencies are increasingly the choice of trading partners. Moreover, we encourage this development. Since the basket represents currencies of countries covering a significant share of China's external trade, the RMB exchange rate against a basket of currencies is therefore a better indicator of the value of RMB and the changes in China's terms of trade than that against the US dollar, and consequently serves as an important reference in achieving basic trade balance in goods and services.

-- currency structure of foreign debt should be considered

As China further opens to the outside world, the size of foreign debt incurred continue to grow significantly. By the end of last year, China's foreign debt reached US$228.6 billion with the origins increasingly diversified. In most cases, foreign debt repayment would require purchasing a specific foreign currency with RMB. The resulting conspicuous demand for this specific foreign currency in the market would become a factor influencing the RMB exchange rate. As such, in determining the currency weights in the basket, we also take into consideration of the currency structure of China's foreign debt.

--FDI should be considered

In recent years, rapid growth has been witnessed in FDI which has been gaining importance in our foreign economic relations. By now, the accumulated FDI flowed into China has reached over US$560 billion, a significant part of which was denominated in the currencies of the originating economies. The investment returns in the form of dividends will need to be exchanged into relevant foreign currency before being repatriated. Therefore the factor of FDI has to be considered in the selection of the basket currencies.

--current transfer items under the current account should also be considered

Though current transfers are not as important proportionally as other items in the current account, the currency structure of these transfers still needs to be considered in the determination of the weights assigned to the currencies in the basket.

In sum, the reform of RMB exchange rate regime to allow RMB exchange rate float with reference to a basket of currencies is in line with the needs of diversifying foreign economic and trade relations as well as the development of the international economic and financial system. Referring to a basket of currencies is not equal to pegging to such a basket. Pegging means mechanically adjusting the exchange rate of RMB against the US dollar according to the exchange rate movements of the currencies in the basket in an attempt to keep the nominal effective exchange rate unchanged. Quite differently, what we are having now is a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies. In comparison with an exchange rate regime of pegging to the US dollar solely, it can better reflect the competitiveness of RMB against major currencies, better absorb the impact generated by an unstable US dollar and moderate the fluctuations of RMB exchange rates at the multilateral level, safeguard the overall stability of China's foreign economic and trade environment and consequently promote the basic equilibrium of balance of payments as well as the sustained, coordinated and healthy growth of the Chinese economy.

Sun Bin said...

right click to download pdf paper of John Williamson, IIE