China's central bank re-adjusts its exchange rate mechanism

On Tuesday (Jan. 9), the yuan dropped 0.5 % against the US dollar to a level of 6.53 after the People's Bank of China announced changes in setting the daily fixing price for the yuan-dollar rate. Under the latest PBoC guidance, banks that participate in setting the daily fixing rate no longer need to include the countercyclical factor which according to market participants has supported the yuan's external value. The central bank refrains from intervening in forex markets as long as the yuan's daily deviations from the fixing rate are less than 2 %. The fluctuations have actually been considerably smaller.

The PBoC introduced the use of the vaguely defined countercyclical factor last May arguing it would be needed to prevent excesses by the markets. With the dollar's depreciation over the past year and confidence returning to the yuan, the central bank saw it possible to return to its old scheme that is based more on pure of supply-and-demand conditions in the market. Of course nothing prevents the reintroduction of the countercyclical factor if conditions change.

China's stated goals are a much freer formation of the exchange rate and deregulation of capital movements, but progress in this direction has been sporadic at best. While liberalisation of capital imports has continued, controls on capital exports have tightened. Last week, Chinese officials restricted the amount of foreign currency private individuals could annually withdraw from their domestic accounts while abroad to 100,000 yuan (USD 15,400), and just 10,000 yuan (USD 1,540) per day. Earlier limits were based on individual accounts. The total amount of currency exchange per person remains at 50,000 dollars per year, but monitoring of such transactions has also been intensified.

China's foreign currency reserves grew last year by nearly 130 billion dollars to 3.14 trillion dollars. This was due in part to fluctuating exchange rates. In 2015–2016, China's currency reserves shrank by over 830 billion dollars.