Interest rate differentials between the US and Australia are set to narrow further, creating Foreign Exchange opportunities for investors
The Chinese Government’s surprise move to devalue the Yuan and make daily prices subject to market forces has prompted debate.
China’s official currency is called the Renminbi which means “people’s currency”, however, prices of goods in China are quoted in Yuan so the two terms are often used interchangeably. Chinese Yuan traded within China is commonly referred to as CNY. However, due to controls limiting the movement of currency into and out of China, China also has a version of its currency which can only be traded and settled by offshore banks in designated trading hubs like Hong Kong and Singapore. This offshore version of the currency is known as CNH.
China has capital controls restricting currency transactions that relate to movements of capital that is, debt or equity-related transactions into and out of China for loans and equity investment purposes. Currency movements relating to normal business transactions such as imports and exports of goods and services are permitted, subject to presentation of documentation. Because of these restrictions and limits on the supply of CNH in circulation, the two exchange rates usually differ. For example, one US Dollar currently buys 6.44 Yuan (CNH) outside of China but only 6.39 Yuan (CNY) within China.
Capital controls exist to allow the People’s Bank of China (PBoC) and the State Administration of Foreign Exchange (SAFE) to control the exchange rate. China has a managed exchange rate regime where it manages the Yuan against a basket of currencies including the US Dollar, Euro and Yen. However, in practice it manages its currency primarily against the US Dollar.
China has traditionally managed its currency by publishing a target exchange rate each day around which the Yuan is permitted to fluctuate in a fixed percentage band. At present, the onshore Yuan in Shanghai (CNY), has moves limited to 2% on either side of the daily target or fixing rate. The PBoC and SAFE then back up their commitment to the daily trading band by either using part of its US$3.7 trillion in foreign exchange reserves, mainly held in US government treasury bonds, to buy Yuan or as the currency issuer, the PBoC can simply print new Yuan and sell these into other currencies to create additional foreign exchange reserves.
For many years, China was accused of deliberately maintaining an undervalued currency aimed at helping its export-driven economy. However, over the past 10 years, it allowed its currency to gradually appreciate by 30% to around 6.2 Yuan per US Dollar before the recent surprise move to devalue the Yuan by 2%. It also announced that daily fixing will be based on market makers’ quotes, together with the previous day’s close, rather than the previous government-decreed rate. These moves saw the currency fall 4.4%, and spooked investors into thinking that China will competitively devalue the Yuan to stimulate exports, which have suffered as a result of a stronger Yuan/US Dollar relative to Asian competitors such as the Korean Won and Japanese Yen.
Another view promoted by the PBoC is that the move was part of a shift to liberalise its economy and currency, so prices are set by market forces, not by the government. A free-floating currency and freer capital controls also helps China’s stated aim to get the Yuan recognised by the International Monetary Fund as a global reserve currency which would largely be a symbolic move. As seen recently with the Chinese Government’s attempts to halt China’s stock market decline, it’s unclear if the Chinese government is always comfortable with allowing fully free-market prices and exchange rates when prices don’t always head in a direction that suits China’s broader policies.
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