Central bank's explanation of yuan reform weakens appreciation expectations

15:22, August 03, 2010      

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Since China's central bank announced the further reform of the yuan exchange rate system on June 19, yuan appreciation expectations have eased despite the relatively larger fluctuations in the first and second week thereafter and based on the greater two-way volatility in the recent weeks.

Since mid-July, central bank officials have specifically analyzed the yuan issue several times, which has helped market players to fully understand the foreign exchange system reform and partly stabilized market expectations.

In the second half of July, five articles written by central bank vice governor Hu Xiaolian successively appeared on the central bank Web site, all of which focused on a managed floating exchange rate regime. This has aroused wide attention in the market.

Hu said that because a managed floating exchange rate regime is China's established policy and in line with China's long-term and fundamental interests, China should continue to adhere to the policy. Meanwhile, improving the managed floating yuan exchange rate regime and gradually increasing exchange rate flexibility will expand the flexibility and effectiveness of China's monetary policies and boost its macroeconomic regulation capacity.

Moreover, further expanding the flexibility of the yuan exchange rate may interact with the ongoing reform of production factor prices and gradually enhance Chinese enterprises' exchange-rate-related bearing capacity.

A series of articles by Hu, published just one month after the central bank announced the further reform of the yuan exchange rate regime, has helped the market to view the yuan exchange rate formation system and its impact in a comprehensive and dynamic manner. The articles also eliminated some inaccurate interpretations.

The series of analysis articles has indeed given the market a "sedative injection," the role of which was markedly reflected by the changes in the market expectations of yuan appreciation.

The yuan exchange rate against the U.S. dollar closed at nearly 6.8 on the inter-bank foreign exchange market on Aug. 2, and the one-year forward exchange rate of the U.S. dollar against the yuan is at a discount of 650 basis points in the forward market. This means the yuan exchange rate against the U.S. dollar will be a little more than 6.7 one year later and the yuan exchange rate will only appreciate by 0.96 percent. However, it was expected that the yuan exchange rate against the U.S. dollar would appreciate by 1.8 percent one year later just after the exchange rate reform restarted on June 21.

The fluctuation in both directions of the yuan exchange rate has obviously been amplified since June 21, therefore the market's expectation towards yuan appreciation obviously decreased, according to the "Analysis on China's Macroeconomic Situation at the Second Quarter of 2010" recently released by the central bank.

Hu recently said during an interview that since China further improved the exchange rate reform on June 19, the biggest fluctuation of the yuan exchange rate against the U.S. dollar was 329 basis points in one day, and the smallest was 34 basis points. The daily average fluctuation stands at more than 90 base points, an obvious increase compared with the 70 basis points from July 2005 to July 2008.

Although the fluctuation in both directions of the yuan exchange rate has been increased, it did not show any major fluctuations in the spot market. In addition, Yi Gang, deputy governor of the People's Bank of China and administrator of the State Administration of Foreign Exchange (SAFE), also said that the yuan exchange rate will not undergo wild fluctuations because China is capable of maintaining the flexible exchange rate mechanism and the general stability of the yuan exchange rate at a reasonable and balanced level.

By People's Daily Online

(Editor:祁澍文)

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