(Editorial note: China continues to restrict its currency to a “trading band” rather than an inflexible peg.)
On July 21, 2005 Chinese monetary policy makers surprised the country’s trade partners by revaluing the yuan 2.1% higher against the dollar, ending a fixed exchange-rate regime that angered officials in the U.S., Europe and Japan and depressed the value of Chinese goods.
[ by Joseph Adinolfi | July 21, 2015 | MarketWatch ]
Policy makers swapped the fixed exchange-rate system for a managed float that would tie the yuan’s value to a basket of currencies and allow its value vs. the dollar to fluctuate in a band around a daily reference rate. That band has gradually grown looser, from plus- or minus-0.3% in 2005 to plus- or minus-2% as of March 2014.
The decision was a milestone in China’s continuing transition away from a closed economy, which began in 1979 when the country’s leaders first opened China to foreign investment.
World leaders applauded the system, praising its potential to stoke global growth and improve economic stability.
In the years since, the yuan USDCNY, -0.0048% also known as the renminbi, has appreciated 30% against the dollar. China’s current-account surplus has shrunk to 2% of its gross domestic product, from a massive 11% in 2007. Officials in the U.S. and elsewhere have toned down angry rhetoric accusing China of waging a trade war. And earlier this year, the International Monetary Fund declared that the currency is fairly valued.
Chinese officials are now hoping to coax the IMF into accepting the yuan into its special drawing rights currency basket. SDRs are a special reserve asset created by the IMF and designed to be a reserve asset for central banks. Their value is derived from the dollar, euro, British pound and Japanese yen, with the dollar the most heavily weighted among those. The IMF is expected to make a decision by the end of October.
The IMF, however, requires currencies included in the basket to be “freely usable.” Most economists believe that the yuan doesn’t meet this criteria.
But economists widely expect the trend of policy liberalization to continue. In a note to clients released over the weekend, economists from HSBC said China is ready to give the yuan “its final push towards full convertibility.”
They expect China to continue widening its trading band in the near future, while making the components of its reference rate more transparent and market-based (the exact formula for setting the reference rate isn't publicly known).
Right now, foreign investors can only trade the yuan through certain offshore hubs like Hong Kong, London and Singapore. That restriction will soon be lifted, too, the HSBC economists predict.
Over the last 10 years, the yuan and the Chinese economy have taken huge strides. Over the next 10, the remaining barriers to free trade and investment could disappear.