Yuan exchange rate, what can China afford?

China does not have a floating exchange rate for its currency. Is this an isolated case? No, the majority of countries in the world have not adopted this system.

How is the rate of the yuan fixed?

The central bank determines it every morning at 9:15 am based mainly on two factors, the previous day’s closing rate and the fluctuations of a basket of currencies, including the dollar, which weighs 21.59%, the euro 17.40%, and the yen 11.16%. All currencies in the basket :

Exchange rate of the renminbi chinese currency

At 9:00 am, thirteen financial institutions quote prices, and the average rate is the rate set at 9:15 am. Transactions can start at 9:30 am with a maximum fluctuation of 2% up or down around this central rate. In August 2015, the authorities allowed the yuan to fluctuate, a fall of the currency, and a 15% drop of the Shanghai stock exchange in two days followed. Faced with the massive outflow of capital in 2016, the central bank in 2017 put in place mechanisms to avoid too strong movements, called “counter-cyclical regulatory factors 逆周期调节因子.”

More elasticity?

Part of the Chinese financial world wants more elasticity in the Chinese currency. For Sheng Songcheng, former director of the People’s Bank Statistics Bureau, it is not a good idea to move from a fluctuation margin of 2% to 3% or even 4%. 2% is already a significant movement. The economy and businesses need hope and stability. Such magnitudes are not going in the right direction.

China, an isolated case?

He reminds us that currency controls have always existed in various ways. The Japanese government intervenes when conditions require it. In 2003, to avoid the yen’s rise, the Bank of Japan bought $150 billion on the markets. During the European debt crisis, the Swiss currency soared. The Swiss National Bank acquired massive amounts of euros to curb the rise of its money. In September 2011, it even set a floor rate: “The current overvaluation of the Swiss franc is extreme. It poses a serious threat to the Swiss economy and carries the risk of deflationary developments. The Swiss National Bank (SNB) is therefore aiming for a substantial and lasting weakening of the franc. Today, it will no longer tolerate exchange rates below 1.20 francs to the euro on the foreign exchange market. »
Exchange controls similar to the Chinese system are exercised in many countries, and according to IMF data, 46.4% of countries in the world practice it, compared to 34.6% in 2009. Moreover, the National Bureau of Economic Research in Cambridge in the United States goes even further. Out of a sample of 196 countries, it estimates that 80 percent have a limited flexibility regime with inflexible exchange rates despite the excellent policy rhetoric.

Floating exchange rates, luxury

Of course, I’m not deaf. The Fox channel has been saying for at least 15 years that China is manipulating its currency, which many people repeat without really knowing the situation. A floating exchange rate and convertibility of its currency are considered a luxury in emerging countries. Indeed, China has moved beyond this stage, but it cannot yet afford such freedom. It may be the world’s second-largest economy, but 70% of its population has an income of less than 2,000 yuan per month, and structural problems are legion.
The few openings have shown capital outflows and fluctuations that disrupt the economy. The government’s objective is not to meet Washington’s requirements, but it must first protect the country from risks. Permitted fluctuations, indexed on a basket of currencies, with a central rate and a 2% fluctuation margin, is for the moment the only luxury Beijing can afford. However, the future is being prepared for with the progressive internationalization of the yuan and digital currency introduction. Convertibility and the floating rate are not yet on the list, even if they are debated. In five years, ten years? Greek Calends?

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17 november 2020

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