From Fixing to Signaling, How China Manages the Yuan

(Bloomberg) -- Monitoring how the People’s Bank of China handles its “managed float” system for the foreign-exchange market isn’t easy: The central bank has various tools at its disposal, some public, some hidden. While its thinking is essentially unknowable to outsiders, there are ways to observe how it seeks to influence the currency. Some measures are more murky, such as Beijing’s plan to use a liquidity squeeze to prop up the yuan; and some have become more predictable and transparent over the years, like the daily reference rate. The so-called fixing, which has long been seen as a policy signal on the Chinese exchange rate, has been recently set at levels that were in line with average estimates in Bloomberg surveys. That’s a sign that the authorities are allowing the market to drive the yuan more.

Here are some of the other most-watched ways:

Daily fixing

The most obvious way the PBOC influences the currency is by setting a reference rate each trading day at 9:15 a.m. Beijing time, known as the daily fixing. The yuan is then allowed to move 2% in either direction. The rates are calculated with formulas that take into account factors including the prior day’s official close at 4:30 p.m, the yuan’s move against a basket of currencies and changes in other major exchange rates. Therefore, encouraging declines at the official close allows the central bank to set weaker fixings without sending a strong signal on policy or destabilizing markets.

The fixing has gone through rounds of reform over the years, with the aim of making it more market-based and transparent. Here are some key milestones in the rate’s evolution:

• January, 2006: China starts to allow the yuan to trade within 0.3% against the dollar of the fixing
• May, 2007: China widens the yuan’s trading to 0.5% on either side of the fixing
• April, 2012: The PBOC widens the trading band to 1%
• March, 2014: The trading band was expanded to 2%
• August, 2015: China devalued the onshore yuan in its most dramatic foreign-exchange reform in a decade. In a push to make the fixing more transparent, the PBOC laid out the factors that banks need to consider as they submit prices for the rate
• From 2017 to 2020: A counter-cyclical factor was installed and removed several times in the fixing formula, as Beijing sought to keep the yuan steady through rounds of depreciation and rallies

Counter-cyclical factor

In 2017, the PBOC introduced a so-called “counter-cyclical factor” in the formulas that commercial banks use to calculate and contribute to Beijing’s daily reference rate. The move was made to avoid a fixing that the central bank deems excessively weak. It removed the component in January 2018 when the yuan was surging. About seven months later, the factor was reinstalled to limit weakness. And in October 2020, lenders said they stopped using the factor recently.

Verbal warning

The PBOC’s standard line on the currency goes: “The yuan will be kept basically stable at reasonable, equilibrium levels.” But Chinese officials aren’t averse to talking their currency up or down when needed. For example, in October 2019, PBOC Governor Yi Gang said the currency was at an “appropriate level,” in a move to help slow the yuan’s depreciation back then.

Capital controls

Controlling the flow of funds in and out of the country is one of the bluntest instruments. China moved to limit outflows in the wake of the yuan’s devaluation in 2015, imposing strict restrictions on everything from overseas takeovers by Chinese companies to consumers buying insurance policies in Hong Kong, and there has been little sign of a let-up. Conversely, the government has been keen to encourage inflows. In September, it expanded the range of investment options available to foreigners under the Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors programs.

Foreign reserves

China also has a war chest of foreign reserves, the world’s largest at more than $3 trillion. Policy makers sold billions of dollars in the aftermath of the 2015 devaluation to support the yuan. (That stockpile has recently stabilized.) While this can be a useful indicator, it is also influenced by broad gains in the dollar, which can lead to a drop in China’s reported reserves. These declines aren’t necessarily a result of intervention, but rather because non-dollar assets in China’s stockpile will have depreciated against the dollar.

Liquidity squeeze

Driving up the cost of betting against the yuan offshore has long been seen as a favored tactic when China wants to curb declines. The key is to mop up liquidity -- Hong Kong is by far the biggest market -- so that traders have to pay higher interest rates to borrow the yuan. That can be achieved by having agent banks buy the currency or decline to lend their supply to other banks. The PBOC can also sell Chinese government bills in Hong Kong. The cost for banks to borrow yuan overnight, known as Hibor, surged to more than 20% on several occasions in the past few years, most notably in January 2016 when it climbed to almost 67%. Another squeeze came in August 2018, when the cost of betting the yuan would weaken soared amid speculation that China was restricting domestic banks’ ability to lend yuan offshore.

The Reference Shelf

• More QuickTakes on China and currency manipulation, interest rates, financial sector opening and its slowing economy.
• Yuan-denominated bonds have become a new haven for global investors, supporting the currency in the long run.
• Bloomberg Opinion’s John Authers asks whether now is the time to buy Chinese bonds.

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