Self-described market reform step follows poor trade data

The People’s Bank of China (PBoC) issued a note August 11 that revises its calculation for setting the Yuan exchange rate. The timing aligns with efforts to further prop up growth in non-financial sectors, says IHS.

Effective August 11, the official daily central parity rate will be based on the closing rate of the interbank foreign exchange rate market from the previous day, the supply and demand in the market and the price movement of major currencies. Previously, the central parity rate was set using an unpublished formula based only on a basket of currencies that was widely believed to be prone to official intervention.

As a result of the change, the Chinese Yuan central parity rate depreciated from 6.1162 versus the dollar on August 10 to 6.2298 on August 11, the largest one-day drop recorded under the central parity regime. Under that system, the actual exchange rate can vary as much as 2% from the central parity rate each day. The central bank described the depreciation on August 11 as a “one-off” adjustment that bridges the old central parity rate with actual market conditions.

Growth in most sectors of China’s economy, except finance, slowed during the second quarter. Leading the deceleration was China’s export-dependent industrial sector, which has lost its share of the market in recent years, but nonetheless still remains a significant contributor to both total output levels and employment. Financial sector volatility since June has cast significant doubt on the ability of finance to further support growth in the second half.

Export performance has been highly erratic and generally poor in China during 2015. While the USD-CNY exchange rate was relatively stable over the past several quarters, the Yuan’s real effective exchange rate against all trading partners appreciated by more than 10%.

“While the central bank described the change as a step towards greater market forces, which it may ultimately be, the timing certainly aligns with current efforts to further shore up growth in non-financial sectors,” says Brian Jackson, IHS Global Insight economist. “In addition, the government is keen to highlight steps towards greater marketization and transparency in its exchange rate regime, given its interest in joining the IMF’s Special Drawing Rights (SDR) basket.” The SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries’ official reserves.

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