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Foreign Exchange Market

China tweaks yuan basket to play down US dollar

Central bank adds 11 currencies to trade-weighted basket

PUBLISHED : Sunday, 01 January, 2017, 8:03am
UPDATED : Sunday, 01 January, 2017, 8:03am

China is reducing the share of US dollars in its currency basket for measuring the yuan value, a technical adjustment to redirect market attention from the yuan-dollar parity.

Although other central banks, including the US Federal Reserve and European Central Bank, also release similar nominal effective exchange rate indices for their currencies, calculated against a basket of trade partner currencies, the People’s Bank of China has been particularly active in promoting the yuan’s rate against a group of currencies, rather than the dollar alone.

As part of Beijing’s efforts to stabilise expectations of the yuan’s value, China’s monetary authority has repeatedly said it’s not fair to look at the yuan solely against the US dollar, which has been strengthening, particularly after Donald Trump won the presidential election. The yuan lost about 7 per cent against the dollar in 2016, becoming the worst-performing major Asian currency that year, and recording its largest annual loss against the dollar since 1994.

The China Foreign Exchange Trade System, the onshore foreign exchange market under the central bank, said on Thursday night that it would expand the currency basket to 24 foreign currencies from the start of 2017, from the current 13 currencies. The new members include the Korean won, Swedish krona, Saudi riyal, Hungarian forint and Poland zloty.

As a result, the weighting of the US dollar in the basket will fall to 22.4 per cent from the previous 26.4 per cent.

It is the first time China has adjusted the basket weighting since it published the trade-weighted basket in December 2015 to reduce the excessive focus on the yuan rate against the dollar.

In addition to the trade-weighted basket, China has another two baskets to measure the yuan – the Bank for International Settlements basket of 40 currencies and the Special Drawing Rights basket of four currencies, which are the dollar, the euro, the sterling and the yen.

China cuts US dollar weighting in key currency basket

Referring to these baskets, China’s central bank said the yuan value is stable. Ma Jun, the chief economist at the central bank’s research bureau, said at a briefing early in December that the problem is not that the yuan is weak but that the dollar is strong.

While the Chinese government is flagging the importance of looking at the yuan’s fair value against a group of currencies, the US dollar remains the dominant foreign currency in real trade.

According to the latest quarterly monetary policy report, yuan-dollar parity turnover in China’s onshore foreign exchange market was worth 9.6 trillion yuan (US$1.38 trillion) in the third quarter, or more than 80 times the euro-yuan turnover. Turnover between the yuan and Saudi riyal in the third quarter amounted to only 14 million yuan.

However, it still makes sense for Chinese policymakers to expand the trade-weighted basket, analysts said.

The addition of 11 more currencies to measure the yuan’s effective exchange rate can better reflect China’s real economic activities with its overseas counterparts, which is encouraged by policymakers, said Xie Yaxuan, the research head of China Merchants Securities.

“It makes more sense that the Chinese yuan remains stable against a set of currencies of its neighbouring countries such as South Korea, Singapore, Indonesia and Malaysia, which have strong trade ties with China,” Xie said.

Yuan ends 2016 with biggest annual loss since 1994

In the new weightings, the Korean won, for instance, ranked the fourth most important currency in the basket, after the greenback, the euro and the Japanese yen.

The adjustment is primarily symbolic.

Lu Zhengwei, chief economist with Industrial Bank, said the basket change was very minor and would “have hardly any substantial impact on the yuan’s value”.