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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 PBC explained that it's the supply and demand of foreign exchanges that decides changes in the renminbi exchange rate. Since the ratio of the current account surplus against the GDP fell to 2.1 percent in 2013, many felt the renminbi had lost the fuel for appreciation. Meanwhile, because financial risks are kept under control and foreign exchange reserve is sufficient, there are no grounds for a sharp depreciation.

Hence, as the marketization keeps progressing, two-way fluctuations of the renminbi will become normal in the future just like other major currencies around the globe. Yet, the central bank is prepared to make some necessary adjustments if things go off the track.

According to an analysis report released by JP Morgan, the band widening itself will have little impact on the economy, and the possible consequence could be used to stabilize the growth. The weak economic data imply that it is unlikely that renminbi appreciation and capital inflows will be seen after the band widening. If that happens, renminbi depreciation could support exports, and capital outflow will drain domestic liquidity and open the window for reserve requirement ratio cuts by the PBC.

"We do not think the renminbi is shifting toward a depreciation trend. In the near term, we expect the renminbi to remain stable," said the report.

Although the band widening may increase the possibility of depreciation for the moment, in the long run, the renminbi will go through a cycle of small appreciations.

Boosting exports

These days, all major currencies employ a floating exchange rate system, which propels exporters to face up to fluctuations in the exchange rate of domestic currency against foreign currencies. It's safe to say that the renminbi exchange rate is more stable in comparison with that of the developed world and other emerging economies. The United States, Europe and Japan adhere to a free floating regime, while other countries that practice a

managed one see that their exchange rates are far more volatile than the renminbi.

Since the exchange rate reform in 2005, Chinese exporters have become increasingly accommodated to exchange rate fluctuations. The band widening, by and large, will urge enterprises and individuals to value exchange rate as an important factor affecting and facilitating resource allocation, as well as intensifying the resilience of the macro-economy.

The change from unilateral appreciation to two-way fluctuations will please exporters and stimulate importers to actively deal with uncertainties.

China has set its foreign trade growth target at 7.5 percent for this year, lower than the 8-percent goal of 2013. Despite that, challenges still exist. According to statistics from the General Administration of Customs of China, the country's exports totaled $114.1 billion in February, down 18.1 percent year on year, marking a record low since September 2009. That's because international purchasing power has not yet completely recovered from the global financial crisis and the renminbi appreciation in the past has squeezed many Chinese export-oriented companies out of business.

An analysis report from Shanghai-based Shenyin & Wanguo Securities, a leading brokerage company, says the inflow of hot money, to some extent, would be restrained. Since hot money always aims to exploit the margins between exchange rates and interest rates, the band widening will force speculators to take volatility into account and possibly withdraw from the Chinese market. When the renminbi exchange rate is heading toward stability or alternating between depreciation and appreciation, export companies will be unburdened of their pressures.

However, the widening will make it more difficult for export companies to decide when to settle accounts. Instead of making decisions based on the assumption of a rising yuan and a devaluing U.S. dollar, enterprises now have to consider the timing of settlement and hedging. Otherwise, the profits that have already come into their hands may be diminished.

The PBC believes the adjustment was not enough to shock enterprises and financial institutions, and would help them strengthen the awareness of mitigating risks with hedging tools.

Email us at: lanxinzhen@bjreview.com

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