The People’s Bank of China (PBOC), the country’s central bank, said it would increase the flexibility of the yuan, which has been tightly pegged at about 6.83 to the dollar since July 2008. In setting the exchange rate, it would pay heed to a basket of currencies, it said, as well as “market supply and demand”.
In China’s fledgling foreign-exchange market, the central bank sets a central dollar parity for the yuan each morning. For the past two years, it has allowed the currency to move barely a whisker from this rate. Now it seems prepared to let it rise by up to 0.5% on any given day—but not to let it rise by that much day after day. On the Monday after its statement, the PBOC let the currency appreciate by over 0.4%, generating quite a bit of excitement. At that rate the yuan would double in value in just 174 trading days. The next morning the central bank set its parity to reflect the previous day’s close. But as Tuesday wore on, it decided that “market supply and demand” needed a bit of a nudge. Heavy dollar-buying by the country’s big state banks, presumably at the PBOC’s behest, pushed the yuan down against the dollar, allowing the central bank to set a Wednesday-morning parity of 6.81 …
The last time the central bank let the currency crawl, it clambered up by 21% against the dollar over three years. But it may not match that pace this time. China will not want the yuan to get too far ahead of other significant currencies that may be falling against the dollar. As the central bank says, China now has a “long and diversified” list of trading partners. Against a broad basket of their currencies, the yuan has already risen this year; against the euro it has strengthened by 17%.
On any given day the yuan may also slip, as well as climb, against the dollar. The central bank is keen to deter “hot money” that might seep past the country’s capital controls, looking to profit from a stronger currency. The currency forwards market expects the yuan to appreciate by only 2.2% over the next 12 months, a slender return given the hassle of getting money in and out of China.
Even without the central bank’s guidance, the upward pressure on the yuan may be more bearable this time. We must point out that China’s trade surplus has narrowed significantly. Six months ago the yuan would have to strengthen by 40% against the dollar to restore “equilibrium”, defined as a current-account surplus of 3% at full employment. Now it would have to climb by only 24% against the dollar and 14% against its trading partners overall.
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