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UPDATED: July 23, 2014 NO. 14 APRIL 3, 2014
Widening the Band
Two-way fluctuations of the renminbi exchange rate will become quite common in the future
By Lan Xinzhen


The floating band of the renminbi's trading prices against the U.S. dollar in the inter-bank spot foreign exchange market was enlarged from 1 percent to 2 percent on March 17, marking a further step toward the marketization of the renminbi exchange rate formation mechanism.

Since the People's Bank of China (PBC), the central bank, began to allow a floating exchange rate in 1994, this has been the fourth adjustment and the most radical one. The floating band of the renminbi's trading prices was expanded from 0.3 percent in 1994 to 0.5 percent in 2007, and then to 1 percent in 2012. According to the PBC, the latest move makes up part of a progressive reform, and took into consideration the adaptability of all economic entities.

The expansion of the floating range reflected the central bank's resolution to push forward the marketization of the pricing of financial factors, which was a key component of the financial reform this year, said Ding Zhijie, Dean of the School of Banking and Finance at the University of International Business and Economics.

Ding said that, since July 2005, the PBC has adhered to a managed floating regime in reference to a basket of currencies based on market supply and demand. However, the basket of currencies was not mentioned in the central bank's announcement this time, indicating less administrative intervention.

During the Third Plenary Session of the 18th Communist Party of China Central Committee held last November, it was advocated that the market should play a decisive role in resource allocation. Given that the exchange rate is an important price in the market, the expansion of the floating range will increase the flexibility of the renminbi exchange rate, enhance the effectiveness of capital allocation, give full play to the market, and accelerate the transformation of the economic development model and economic restructuring.

As the PBC suggests, China's foreign exchange market has seen continued increase in transaction volume, a wider selection of transaction categories, and a stronger will for independent pricing. In this sense, the 2-percent loosening of the floating band is suited to the current status.

The renminbi exchange rate will most likely go up after a round of depreciation, argued Zong Liang, deputy head of the international finance institute of the Bank of China. But the regulator should properly encourage the public to shun expectations for a tendency of constant devaluation, which would undoubtedly deal a blow to macroeconomic and financial stability.

In response to the voices favoring a root-and-branch renminbi liberalization, Lu Zhengwei, an economist from Industrial Bank, held that China would shift to such a mechanism when the time was ripe. If the renminbi exchange rate was completely loosened, China's financial system would take a heavy toll, said Lu.

More flexible

From the restart of the renminbi exchange rate reform in 2005, the yuan took on a unilateral appreciation tendency, which came to an end and began to move in the opposite direction in February 2014. On March 17, the day that the trading band was adjusted, the renminbi even depreciated by 279 base points. Some people suspected it was the adjustment that resulted in the devaluation, while others believed the fluctuations marked a new era for the renminbi featuring more floating room and less intervention.

According to documents from the PBC, the enlargement was designed to reinforce the two-way floating flexibility and had no direct links to the ups and downs of the renminbi exchange rate.

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