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How PBOC Controls the Yuan (RMB) Against the Background of the Trade War



A bank employee counts US currencies and Chinese currency notes at a bank in Nanton, Jiangsu Province, China.

Xu Jinbai | Visual China Group | Getty Images

The Chinese yuan is watching closely as its economy slows, and as Beijing remains locked in a trade war with the United States, which is stirring up world markets.

Land yuan fell to levels not seen since February 2008 on Monday, and offshore yuan fell to their weakest since they began trading on the international market around 201

0.

The recent escalation of trade tension left analysts and investors wondering how much further Beijing would allow the currency to weaken.

Here's a look at how China controls the yuan, also known as renminbi.

One currency, two exchange rates

Unlike other major currencies, such as the US dollar or Japanese yen, which have a free floating exchange rate, China maintains strict control of the Yuan's continental exchange rate.

Each morning, the Chinese National Bank (PBOC) determines the so-called daily fixed midpoint based on the previous day's yuan closing rate and quotes taken from inter-bank dealers. The Central Bank also manages China's complex monetary policy

The currency is allowed to trade in a narrow strip of 2% above or below the average rate of the day. If it diverges too far, according to some market observers, the Chinese central bank intervenes to buy or sell the yuan, putting a lid on its daily volatility. This exchange rate is known as Maritime Yuan, or CNY.

The PBOC, which is heavily influenced by the central government, sets a daily midpoint to guide the market and to manage the currency. The well-managed marine yuan has weakened about 4% against the dollar so far this month.

The RMB also trades outside the mainland, mainly in Hong Kong, but also in Singapore, London and New York. [19659002] Known as Offshore Yuan, or CNH, the currency is not as tightly controlled as the marine yuan. Market supply and supply affect the exchange rate of the offshore yuan, but the volume traded is relatively smaller.

How the PBOC Affects the Offshore Yuan

The Central Bank wants to keep the spread between the coast and the offshore yuan as they are technically the same currency, according to experts.

They say that if the offshore exchange rate diverges too far from the land figure, the central bank will intervene to reduce volatility and support the currency, using its huge foreign exchange reserves, which were more than $ 3 trillion by July. PBOC also relies on state-owned banks to enter the offshore market and exchange dollars for yuan.

To prevent the offshore yuan from being depreciated too quickly, the Chinese Central Bank also issues short-term yuan-denominated bills in Hong Kong, essentially wiping out liquidity from the market and raising the cost of yuan borrowing, making it more expensive for people to cut reminiscing.

If traders try to reduce the yuan, they predict that its value will weaken against another currency in the future. One way to do this is to borrow in RMB and pay off at a discount when the value of the currency goes down.

Is there a new carefully observed level of shore?

China allowed its currency to weaken from the psychologically significant level of 7 against the dollar in early August for the first time since the global financial crisis in 2008. This prompted the US Treasury to designate Beijing as a currency manipulator. The PBOC then set the yuan midpoint at above 7 for the first time in 11 years on 8 August.

The CFETS RMB index – which measures the yuan against a basket by its peers – also fell below a carefully monitored level of 92, which has held for more than two years, Tommy Xi, head of research for Greater China at OCBC Bank, told CNBC.

He explained that the market is still trying to find consensus on the next important level for the land currency, with some suggesting it could be 7.20 yuan per dollar.

A Hong Kong-based banker told CNBC that the next closely monitored level could be around 7.25, and depending on the development of the US-China trade war, it could weaken even more more if the levies increase further.

A weaker currency makes Chinese exports cheaper and more competitive in international markets and can potentially offset some of the impact of tariffs.

Still, it is n or likely Beijing will allow the yuan to depreciate too quickly.

This is because it is feared that the rapid weakening of the yuan could lead to significant capital outflows where investors move their assets outside a given country due to perceived volatility and prevent wealth from depreciation. There are also concerns about freezing the credit markets and tightening domestic financial conditions, as it did after the yuan fell 2% in 2015. Since then, China has needed years to stabilize its capital outflow.

Efforts to internationalize

Economic front, making the yuan an international one is a top priority for China, according to some experts.

China stepped up its efforts to internationalize the currency after the global financial crisis when Beijing created the so-called unclear-bond market – or Yuan-denominated yuan, issued outside the mainland and allowed for cross-border reminiscence trading.

For its part, Beijing wants more price power for important commodities such as oil and asset prices such as gold. He wants the yuan to become a reserve currency, much like the US dollar.

The status of the dollar in the global financial market allows the United States to engage in impunity without slowing investors' sentiment toward US assets, the Hong Kong banker explained. If the yuan becomes a popular reserve currency, it could allow China to issue more debt to better manage its domestic needs.

However, China is not yet ready to reduce the limits of fears that there will be huge capital outflows. Chinese investors may move their money outside the country and into the international market.

The Yuan joined the International Monetary Fund's reserve currency basket in 2016. China continues to track its value against other currencies in the RMB index.

But as the US-China trade deal seems increasingly uncertain, the yuan-dollar relationship remains closely watched by investors and economists.

– Reuters contributed to this report


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