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Foreign Exchange

China takes step towards creating reserve currency; decision ‘good news’ for investors

The People’s Bank of China (PBoC) has doubled the daily trading band for the renminbi, as it continues its push to internationalize the currency.

In a move which many see as a further step towards free-floating renminbi, China on Saturday increased the daily trading band in which the currency is allowed to fluctuate after its initial fixing from +/- 0.5% to +/-1%. The new band replaces one maintained since May 2007, before which it was banded at +/- 0.3%.

The Chinese authorities confirmed the decision was to “promote price discovery and increase two-way flexibility”, and also reiterated the government’s commitment to keep the currency “basically stable at a reasonable and balanced level”.

Analysts say the decision is well-timed, given recent signs that the Chinese economy is weakening and that expectations of further renminbi appreciation are more well-balanced than they have been.

“The wider trading band should not be seen as a signal of faster CNY appreciation but a signal of further relaxation of capital controls and a move towards currency convertibility,” says Benoit Anne, head of EM FX strategy at Société Générale.

“Market sentiment remains for weak CNY on the back of growth concerns.”

Indeed, spot USDCNY rose 0.5% relative to its initial fixing of Rmb6.2960 on Monday.

 USDCNY trading band

 
 Source: Bloomberg, ANZ

The move also follows the decision by the China Securities Regulatory Commission earlier this month to lift quotas for global money managers investing in Chinese bonds and equities to $80 billion from $30 billion.

“The decision to double the daily trading band is both bold and commendable given recent signs that the economy is weakening,” says Michael Derks, chief strategist at FxPro.

“Both the renminbi trading-limit expansion and the increase in investment quotas will likely raise demand for dim-sum bonds, in turn contributing to further demand for the currency.”

Simon Derrick, head of FX strategy at Bank of New York Mellon, says the rationale behind the move was straightforward.

“As we have argued for a significant part of the past decade, China needs to move towards currency and capital account liberalization as fast as it reasonably can do,” he says.

“This is not just so that the PBoC has a full set of tools with which to fight inflation or that China’s markets can become rather more stable over time, but to also allow it to finally stop accumulating fresh reserves that need to be invested in markets that the authorities clearly feel uncomfortable with.”

China, as a result of its policy of limiting renminbi appreciation, has built up the world’s largest FX reserves and has repeatedly chastised the US for undermining the value of the dollar through reckless monetary and fiscal policy.

Some experts note the timing of the move could be seen as an attempt to head off criticism over renminbi weakness from its G20 partners, given that it occurred just one week ahead of an International Monetary Fund and World Bank meeting in Washington.

Derrick adds that after several weeks of political uncertainty in China after the scandal surrounding Bo Xilai, who was suspended from the ruling Communist Party’s Politburo, the decision could be seen as another sign that the “reformers” remain firmly in control in Beijing ahead of the leadership change later this year.

“Given how important this group has been in driving market reforms in China over the past 20 years, this is good news for investors,” he says.

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