1.Why choosing the current time to improve quotation of the central parity of RMB against US dollar?
Currently, the international economic and financial conditions are very complex. The U.S. economy is recovering and markets are expecting at least one interest rate hike by the FOMC this year. As such, the U.S. dollar is strengthening, while the Euro and Japanese Yen are weakening. Emerging market and commodities currencies are facing downward pressure, and we are seeing increasing volatilities in international capital flow. This complex situation is posing new challenges. As China is maintaining a relatively large trade surplus, RMB's real effective exchange rate is relatively strong, which is not entirely consistent with market expectation. Therefore, it is a good time to improve quotation of the RMB central parity to make it more consistent with the needs of market development.
Since the reform of the foreign exchange rate formation mechanism in 2005, the RMB central parity, which serves as the benchmark of China's exchange rate, has played an important role in market expectation and stabilizing RMB exchange rate. Recently, however, the central parity of RMB has deviated from the market rate to a large extent and with a larger duration, which, to some extent, has undermined the market benchmark status and the authority of the central parity. Currently, the foreign exchange market is developing in a sound manner, and market participants are increasingly strengthening their pricing and risk management capacities. The market expectation of RMB exchange rate is diverging, and the preconditions for improving quotation of the RMB central parity are becoming mature. Improving the market makers' quotation will help enhance the market-orientation of RMB central parity, enlarging the operation room of market rate and enabling the exchange rate to play a key role in adjusting foreign exchange demand and supply.
2.Why did the central parity of RMB against US dollar of 11 August change by nearly 2% compared to that of 10 August?
We noticed that the central parity of RMB against US dollar of 11 August changed (in the depreciation direction) by nearly 2% compared to that of 10 August. The following two factors may be relevant. First, after the improvement of the quotation of the RMB central parity, the market makers may quote by reference to the closing rate of the previous day and, therefore, the accumulated gap between the central parity and the market rate received a one-time correction. Second, a series of macro economic and financial data released recently made the market expectation diverge. Market makers paid more attention to the changes of market demand and supply. Compared with the closing rate of 6.2097 Yuan per dollar in the previous day, today's central parity depreciated by about 200 bps. The market still needs some time to adapt. The PBC will monitor the market condition closely, stabilizing the market expectation and ensuring the improvement of the formation mechanism of the RMB central parity in an orderly manner.
3.RMB exchange rate reform: what's next?
Next, the reform of RMB exchange rate formation mechanism will continue to be pushed forward with a market orientation. Market will play a bigger role in exchange rate determination to facilitate the balancing of international payments. Foreign exchange market development will be accelerated and foreign exchange products will be enriched. In addition, the PBC will push forward the opening-up of the foreign exchange market, extending FX trading hours, introducing qualified foreign institutions and promoting the formation of a single exchange rate in both on-shore and off-shore markets. Based on the developing condition of foreign exchange market and the macroeconomic and financial environment, the PBC will enhance the flexibility of RMB exchange rate in both directions and keep the exchange rate basically stable at an adaptive and equilibrium level, enabling the market rate to play its role, and improving the managed floating exchange rate regime based on market demand and supply.
Currently, under the complex international economic and financial condition, we are seeing increasingly large and volatile cross-border capital flow. As such, the PBC and SAFE will strengthen the examination of banks' FX transactions according to relevant laws and regulations, adopt effective measures to fight money laundering, terrorist financing and tax evasion activities, and improve the monitoring of suspicious cross-border capital flow. The PBC and SAFE will severely punish illegal FX transactions, including underground banks, and maintain a compliant and orderly capital flow.
4. Why does the central parity of RMB exchange rate against US dollar change nearly 1.6% on 12 August from that of 11 August?
The central parity of RMB exchange rate against US dollar changed nearly 1.6% (in depreciation direction) on 12 August from that of 11 August. The main reason is that market makers make quotations based on the analysis of financial data of July newly released on 11 August and the announcement of improving central parity quotation of RMB exchange rate against US dollar on the same day.
Due to the existence of intra-day fluctuation in FX market, if the closing rate of previous day deviates significantly from the central parity of that day, the central parity of the following day will deviate from that of the previous day accordingly. The closing rate on 11 August was 6.3231 Yuan per US dollar, depreciating by 1.5% from the central parity on 11 August. This was the major reference for market makers to report quotation on 12 August. Other relevant factors include demand and supply condition in the foreign exchange market and exchange rate movement of major currencies. It is clear that under the managed floating exchange rate regime, the fluctuation of RMB central parity is normal, reflecting not only the enhancement of the market-orientation, but also the key role played by market demand and supply in the formation of exchange rate. After the announcement of improving quotation yesterday, it will take some time for the market makers to adjust quotation and trading practices, as well as explore and find the equilibrium price of the foreign exchange market. This may lead to potentially significant fluctuation of RMB central parity in the short run. After a short period of adaptation, the intra-day exchange rate movements and the resulting central parity fluctuation will converge to a reasonably stable zone.
5. Will the central parity of RMB against US dollar converge to the equilibrium market rate?
As noted by several market observers, the improvement of central parity quotation helps reduce distortion and push central parity of RMB against US dollar towards the equilibrium market rate. Under the managed floating exchange rate regime, the market rate should fluctuate around the central parity, which serves as the benchmark exchange rate. The trading forces in the market will help correct divergence between the market rate and the central parity. Since the third quarter of 2014, China’s significant trade surplus and the appreciation of USD against other major currencies have affected the RMB exchange rate in different directions. Market makers’ expectation diverged, and market rate deviated from the central parity for an extended period. By improving quotation of market makers, we expect market demand and supply to play a bigger role in central parity formation. This should help prevent persistent divergence between central parity and market rate, enhancing the soundness of central parity as a benchmark. In the future, the RMB central parity will be formed, primarily by reference to the equilibrium market rate, and at the same time it will play a guiding role for the market rate.
6. Will RMB depreciate persistently in the future?
In view of both domestic and international economic and financial condition, currently there is no basis for persistently depreciation of RMB. First, China registered a relatively rapid economic growth in the first half of 2015, facing complex and challenging environment both in China and abroad. China’s GDP grew by 7% during the six months ending 30 June 2015, which is considerably higher than most other major economies. The relatively large fluctuation of money supply and credit aggregates in July is temporary and tractable. China will continue to pursue prudent monetary policy. Recently, major economic indicators stabilized and showed good signs, which provides a favorable macroeconomic environment for a stable RMB. Second, China has maintained a current account surplus for a long time. In the first seven months of 2015, the trade surplus of goods reached USD 305.2 billion. This is a fundamental factor in determining the supply and demand of foreign exchange, and is also an important foundation to support the RMB exchange rate. Third, in recently years, the RMB internationalization and opening up of domestic financial markets have accelerated. The international demand for RMB-denominated trade, investment and asset allocation is gradually increasing, which creates new momentum for stabilizing RMB exchange rate. Fourth, the USD has been strengthening for some time due to the market expectation that FOMC will raise its policy rate this year, an event that is being absorbed by the market. We believe that the market will have a more rational judgment on exchange rate after the temporary shock of a rate hike. Finally, China maintains abundant foreign exchange reserve, stable fiscal condition and a healthy financial system, which should help bolster a stable RMB exchange rate.
China is implementing the managed floating exchange rate regime based on market demand and supply. The fluctuation of exchange rate is a normal phenomenon, to which, we should take an objective view. In the future, the PBC will strive to further improve market-based formation mechanism of RMB exchange rate, maintain a normal fluctuation of RMB, and keep the exchange rate basically stable at an adaptive and equilibrium level.