20 August 2019

Bigger RMB swings give speculators less room to move

The daily trading band of the renminbi’s exchange rate was doubled to 2 percent from Monday. The Hong Kong Economic Journal’s Investor Diary column examines how this change could affect the market.

In general, greater volatility means importers and exporters may have to spend more on currency hedging. For speculators, betting on the Chinese currency now carries a lot more risk. So much so that brokerages all of a sudden reversed their upbeat view on the currency. Daiwa Securities Co. Ltd. even forecast the renminbi will depreciate by 10 percent against the U.S. dollar by the end of next year.

The People’s Bank of China decided in February to set orderly expansion of the renminbi’s trading band as one of its major policy targets for this year. It then guided the spot rate lower by adjusting the daily fixing rate downward.

The reference rate was set at a three-month-plus low of 6.1346 to the U.S. dollar Friday, sending both the onshore and offshore renminbi lower. The spot rate in Shanghai closed at 6.1502 the same day.

The renminbi’s decline over the last two weeks has swept away all of its gains since May last year. But, some mainland economists say the trading band is still not wide enough to reflect the volatility in the currency’s demand and supply.

Yu Yongding {余永定}, an academician of the Chinese Academy of Social Sciences and a member of the National Development and Reform Commission’s advisory committee on national planning, has suggested that the band be expanded to as much as 7.5 percent per day.

Increasing the flexibility of the currency regime could help the central bank withdraw from intervention, freeing its hands to deal with monetary policy that benefits both the foreign exchange and interest rate markets.

But if the central bank did take Yu’s idea on board, the renminbi would effectively become a free-floating currency. And that thought is too much to consider right now.

The renminbi regime is different from the Hong Kong dollar peg system that links the city’s currency at 7.8 to the U.S. dollar, with a defined floating range between 7.75 and 7.85. The Hong Kong Monetary Authority will intervene only when the range is under challenge. But, there is not such an explicit range with the renminbi regime.

The recent decline in the Chinese currency largely reflects the central bank’s lower daily fixing since the Lunar New Year holiday and sends a renminbi softening signal to the market.

There are three possible motives for this. First, the central bank wants to discourage speculators from betting on renminbi appreciation and generating inflows of hot money. Second, it allows market forces to play a bigger role in determining the exchange rate levels, paving the way for the internationalization of the renminbi. And third, the weaker currency can boost export volumes to support a lackluster economy.

The central bank, however, must be wary of triggering massive fund outflows and a liquidity crunch.

This all means that speculators are finding it a lot more difficult to make money. Even if the renminbi’s medium-term uptrend stays in place, short-term uncertainty has greatly increased.

Players of leveraged products such as Target Redemption Forward contracts are now exposed to much higher risks. A total of US$350 billion worth of such contracts is estimated to be held by hedge funds, high-net-worth individuals and non-finance corporates.

As the structure multiplies the impact of currency movements in both directions, it is more vulnerable to adverse changes that can easily trigger margin calls.

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Freelance journalist

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