Reforms, Fast and Slow: The Near-term Outlook for Reforms to China’s Exchange Rate Policy

THERE is the sweet scent of reform in the air these days in Beijing, but not all reforms are equally sweet for China’s leadership. Many analysts are optimistic about the prospects for reform following Premier Li Keqiang’s speech to the National People’s Congress on March 5th, and also with the recent announcement that by the PBoC that the daily trading band on the renminbi will be widened to +/-2% from the previous +/-1%. Some of this optimism is certainly justified. However, despite official statements calling for further internationalization and marketization of the renminbi, reforms to China’s currency policy have been slow and inconsistent thus far, and the outlook for deeper, more meaningful market reforms remains dubious.

Last November, calls from the highest levels of Chinese officialdom lamented the inefficacy of continued interventionist policy, leading some to believe deep and aggressive reforms could be just around the corner. Indeed, the renminbi appreciated to its lowest historical levels following those speeches. However, the widening of the daily trading band is a small measure which has been widely expected and does very little to enhance the overall liberalization of the currency. The PBoC still retains the ability to set the fixing rate (the rate around which the market clearing rate ‘floats’), and thus retains absolute autonomy over the pace of appreciation, irrespective of how wide the trading band is. A more concrete step in addition to widening the trading band, for example, would be to pre-commit to set the daily fixing rate +/- 1.5% (more, or less) of the previous day’s closing price. This way the market would have an explicit role in determining the pace of appreciation (or depreciation). However, a step that would limit the PBoC’s absolute discretion over the currency seems unlikely at this stage.

Exhibit 1: CNY fixing rate versus CNY closing price

2014.03.24.Exhibit.01

Source: Bloomberg, PBoC

Exhibit 2: Renminbi level and deviation from fixing rate

Exhibit 2

Source: Bloomberg, PBoC, author’s calculations

Exchange rate reform is a low priority for policymakers this year. Currency reform was buried deep in Li Keqiang’s much-publicized speech on reform priorities for 2014. In contrast, fiscal and financial reforms were placed in the front and described as “major priorities.”

In addition, the two major exchange rate reform measures the Premier highlighted for 2014 did not indicate a major change form the status quo. First, the Premier’s call for widening the exchange rate band (扩大汇率双向浮动区间) appears now to be complete and a further widening is unlikely. The second objective to maintain the policy of “stabilizing the exchange rate” (保持人民币汇率在合理均衡水平上的基本稳定) is hardly a call for injecting more market forces.

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