The renminbi has seen two-way fluctuations after years of one-way appreciation. It even went through great volatility in August. What were the underlying reasons?
The reform of the Chinese currency has been a well-managed process over the years, thanks to the limited opening of the capital accounts and the relatively closed onshore foreign exchange market. As Beijing steps up its foreign exchange reform, market forces are set to play a bigger role.
The internationalization of the Chinese currency has progressed faster than expected. Renminbi trading has been limited to the offshore CNH market and onshore CNY market. The daily fixing has had an impact only on the CNY market, not on the CNH.
The renminbi, as a new global currency, is different from other mature currencies like the US dollar, euro or Japanese yen. It also differs from other active emerging market currencies.
On one hand, China’s rising economic power underpins its currency. China managed to maintain steady growth despite the global economic crisis.
The offshore market has strong confidence in the world’s second largest economy, and treats the currency as important as the US dollar and euro.
That is reflected in the rapidly increasing use of the Chinese currency, which has surged to become the fourth most widely used payment currency from the 17th spot within just three and a half years, according to SWIFT data.
The currency has also climbed to the fifth spot in terms of foreign exchange trading and second in trade financing.
The global use of the Chinese yuan is very close to that of four other currencies in the Special Drawing Rights basket of the International Monetary Fund.
On the other hand, China is still a developing economy. Western nations have overcome some risks after the financial crisis, while emerging markets are still struggling with more volatile currencies.
China is also facing unprecedented challenges, including a shift to a lower-range economic growth, economic restructuring and the absorption of stimulus measures.
As a key player among emerging market currencies, the Chinese yuan could see greater volatility along with its rapidly increasing use worldwide.
The redback has ended its long-time one-way appreciation and shifted to two-way movement since last year.
Historical data shows that the offshore CNH has kept hovering around the daily fixing since it was established five years ago. The CNH usually returns to the track soon after a temporary deviation from the mid-point level.
Both onshore and offshore renminbi trading activities are dominated by real trading settlement and payment businesses.
Traders would exchange on the spot or forward market in accordance with the demand, and banks would allocate capital in the market accordingly.
Banks provide the services for the sale and purchase of foreign exchange for companies on the onshore market, while exchanging renminbi for traders and unwinding positions on the offshore market.
Over the years, participants on the onshore and offshore markets are quite similar or even the same. They have similar expectations for the redback.
The cross-border settlement would usually narrow the price gap between CNY and CNH. For example, CNH usually rallies faster than CNY during an appreciation cycle.
As such, traders would choose to settle in renminbi for export to mainland, and exchange into US dollar to pay for imports from Europe or the United Stattes.
When the CNY turns weak, CNH is even weaker. Traders would pay renminbi for mainland imports, and exchange revenue from other currencies into renminbi in Hong Kong.
The operation has arbitraged the difference between the two markets, narrowing the price gap.
The arrangement of clearing and correspondent banks will help align CNY and CNH.
Clearing and correspondent banks could offer cross-border unwinding of positions, or offer direct exchange for CNY onshore as long as there is authentic trading.
In that case, any difference between CNY and CNH could lead to capital movement, and lead both prices to converge.
Ying Jian, senior economist at Bank of China (Hong Kong), contributed to this article.
The article appeared in the Hong Kong Economic Journal on Oct. 14.
Translation by Julie Zhu
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