Joseph Yam on RMB basket "reference" peg

Mr Joseph Yam, Chief Executive of Hong Kong Monetary Authority (the 'central bank') listed 10 questions about the new RMB basket peg mechanism. I am sure he knows the answer to some, given the close communications between HKMA and PBC. Updates: I found his original in HKMA's site, so I am replacing my tranlation (it was quite accurate though, considering I started with the Chinese translated text) as below:

Reference Currency Basket of the Renminbi

The People’s Bank of China is right in taking a gradual approach in releasing further information about the new renminbi exchange rate regime.

The disclosure of the composition, although not the weightings, of the reference currency basket for the determination of the renminbi exchange rate is a courageous step by the Mainland authorities. It is a demonstration of confidence in monetary management, as the People’s Bank of China (PBoC) makes impressive progress in the reform and liberalisation of the Mainland monetary system. There are quite a few jurisdictions operating with a currency basket, whether it is used for reference or as an anchor, and the composition of the basket is, more often than not, kept confidential.

It is always very difficult to strike the right balance, particularly in exchange rate management, between withholding key information, for the purpose of retaining some constructive ambiguity on the one hand, and transparency that theoretically enhances efficiency and credibility on the other. As we are all aware, financial market behaviour is never easy to predict and it has become increasingly less so with globalisation. Much as we would like to promote the operation of free market with full transparency, in order to achieve the highest efficiency in price discovery and allocation of scarce resources, the free market does not always give priority to public interest. It is indeed advisable to keep something up our sleeves, whether it is key information or the right to change the rules of the game.

There are other areas of the renminbi exchange rate regime in which information disclosure may similarly be rather delicate. It will be interesting to observe how information disclosure is handled by the PBoC, following the encouraging comment by Governor Zhou Xiaochuan on 29 July 2005. While supporting transparency, he wisely pointed to the need to consider the ability of the public and the market to digest and absorb the relevant information, and advocated gradualism in its release. I fully support this approach. Meanwhile, I am sure second guessing the PBoC will become a popular pastime of observers, whether they have an academic or market or political interest in the renminbi exchange rate regime, and PBoC watching (like Fed watching) will become the career of many in the financial world.

We closely monitor the renminbi exchange rate, for the obvious reason that the reform of the renminbi exchange rate regime will present us with challenges in managing the monetary system of an economy that is so closely integrated with the mainland. Fortunately, our lines to the PBoC are kept open to ensure that we can carry out our responsibility for monetary stability in the best interests of Hong Kong.

Currently, the focus of market attention seems to be on a number
of issues.

1. First, the details of the currency basket reference; for example, how frequently are references made, what is the nature of those references (directional or quantitative) and what is the action plan associated with those references?
2. Second, the actual weightings of the currencies in the basket; no doubt for the purpose of tracking the extent to which the actual exchange rate eviates from the imputed exchange rate if the renminbi were fixed against, rather than determined with reference to, the basket.
3. Third, whether there is a band within which the actual exchange rate is allowed to deviate from the imputed exchange rate and what happens if one of the limits defined by the band is reached.
4. Fourth, whether there is a transitory operational cap for the daily fluctuation in the exchange rate that is smaller than the announced maximum daily fluctuation of plus or minus 0.3%, given that the largest daily movement seen so far is 60 pips or 0.07% on 11 August.
5. Fifth, the degree of autonomy that the PBoC has in determining the daily movement and the cumulative movement over a period of time.
6. Sixth, the set of circumstances in which changes to the exchange rate band may be contemplated.
7. Seventh, how references are made to market supply and demand in determining the exchange rate.
8. Eighth, whether, in the context of referring to market supply and demand, there is a cap for the rate of further accumulation of foreign reserves.
9. Ninth, the relative importance of the two references – the basket and market supply and demand – in the determination of the exchange rate.
10. Tenth, the extent of involvement of the PBoC, if any, in determining the forward exchange rate and making a market for renminbi forwards.

I can probably think of twenty more of such questions, but I am not pressing for any answers. It is up to the PBoC, having regard to the public interest, to decide whether the relevant information should be disclosed.

Joseph Yam
1 September 2005

I guess Yam's points are

1. These are the most important issues in understanding the new basket regime
2. Despite Zhou's gradual release of information (such as basket weight), PBC still has full control in a duel vs speculators
3. In coming days, some more information may be released, but may be not. PBC needs to think through the implications carefully before doing so
4. Some of the questions might not have a clear answer even among PBC, they need to think through them clearly and set a clear internal rule of operation (and procedure) if that is the case

His insights should provide a good answer to those who do not understand the situation, especially on how translucent this box is and why it is so. In addition, for the 'hard to please' school, who tried to bash PBC first when they thought the basket was opaque and again when it became more transparent, they should read Joseph Yam, whose track record includes successfully managing the HKD peg through the 1998 crisis, and again under appreciation pressure recently.

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Below is my told text. See what had changed after 2 translations (loss of fidelity).

1. How does the "referencing" of the basket work? (directional vs quantitative, frequency of referencing, and action procedures)
2. Weight within the basket (Zhou revealed the principle, but actual split is still unclear): obviously this is for judging how far the actual (market trading) rate departs from the calculated rate (based on the weight/formula), and hence when to intervene
3. Has there been an objective range (gap) set for the calculated weight, and what to do when the boundaries (upper and lower) is touched (the only gap announced was 0.3% for USD, and that the gap would be different for each currency)
4. Up till now (Sep 2nd) the largest gap observed was on Aug11, for 60 base points (0.07%). Does this mean that there is another (transitional/temporal) operating gap which is much lower than the announced 0.3% gap for USD
5. How much leeway PBC has on deciding the daily range, while considering the cumulative drift within a period of time
6. Under what circumstances will PBC (or State Council) consider to adjust for a new gap
7. How to reference demand/supply and determine (quantify) into the desired rate
8. While referencing demand/supply, is there any upper limit on forex reserve
9. Which one of these two factors are more important: basket calculated rate, and market demand/supply. How do they interact?
10. (If there is,) How much would PBC involve itself in the determining of Forward contract and as a forward under-writer

Yam said "I could think of 20 more questions like such, but I am not eager to get the answers. After all, whether to release such information is for PBC to determine, based on its consideration of how it would impact public interests."