On the 11th of August, the PBoC surprised the currency markets by announcing a far higher fixing rate of 6.2298 vs. the previous rate of 6.1162 (10 August). This amounts to a 1.9% depreciation in terms of the daily fixing. Following this, the PBoC announced that the new central parity of CNY exchange rate against US dollar (USD) fixing methodology will be based on actual spot USD/CNY close on the prior day with contributions by a panel of banks and some adjustment for overnight Move in major partner currencies. On the 12th and 13th of August, the PBoC affirms their commitment to the new pricing mechanism by fixing the central parity of CNY exchange rate against US dollar at 6.3306 (vs. previous close of 6.3250) and 6.40100 (vs. previous close of 6.3858) respectively. Hence, over the course of 3 trading days, the CNY had effectively weakened by 3% against the USD.
- The argument in favour of bolstering exports through a relatively minor currency adjustment is not convincing; for some time, Chinese officials have highlighted pro-growth tools at their disposal, and currency devaluation is not one of them. First, Chinese exports today are higher-value added and less price-sensitive than before. Two, in the current global landscape of weak aggregate demand, currency depreciation is likely to provide limited relief at best. Third, the policy signal sits at odds with the longer-term intent to re-orientate the Chinese economy toward domestic sources of growth. Perhaps most damningly, today’s move could potentially lead to an unintended consequence of competitive devaluations globally and destabilise China’s financial system.
- In the quest for CNY internationalisation, policy makers are finding themselves in a catch 22 situation. In order to be considered for Special Drawing Rights (‘SDR’) inclusion, the spot rate needs to be market-determined. Given the over-valuation of the CNY versus the rest of EM, such a move may fuel speculation of a prolonged stepwise depreciation, challenging the official characterisation of today’s move as “one-off”. In the absence of liquid instruments for hedging, the timing of the change is problematic in terms of policy sequencing. Chinese corporates, which have been active issuers of USD bonds in the recent years, may be vulnerable. Recent market worries over destabilising capital outflows could stay elevated.
- There are two other suggestions for the policy move, neither of which we attach a high probability. Some interpreted the move as retaliation toward the IMF’s lack of support for the CNY to be included in the SDR basket, by stoking global market volatility. Others believe this represents a “Japan-style” pursuit of trend currency depreciation as a means to stimulate the stock market, which the Chinese authorities have rejected.
- A plausible theory, however, is that today’s move serves a bargaining chip for SDR inclusion sooner in 2015, and not September 2016. There are 24 members in the IMF Executive Board, each with different amount of votes. A 70% majority of votes is required for formal inclusion. Under unique circumstances that involve a change in “principle”, 85% votes are required. The timing of the move, ahead of President Xi Jinping’s first state visit to the US in late-September, appears to support this theory. Indeed, the case for early SDR inclusion would go a long way in addressing US political rhetoric on Chinese currency manipulation, as a formal recognition paves the way for portfolio inflows to counter depreciation pressure. Last month, the PBoC liberalized market access to onshore bonds for foreign central banks, sovereign wealth funds and global financial organisations.