Yuan to see greater volatility if won and rand are brought into its basket of currencies

Chinese yuan may become daily more volatile against the US dollar if the Korean and South African currencies are included in the basket that the yuan tracks, HSBC Global Research said in a report.

PUBLISHED : Monday, 30 May, 2016, 3:00pm
UPDATED : Monday, 30 May, 2016, 3:00pm

China’s currency may become more volatile against the US dollar if the Korean won and South African rand are included in the basket of currencies that the yuan tracks, HSBC Global Research said in a report.

Media reports have said the Korean and South African currencies will start direct trading against the onshore yuan on the China Foreign Exchange Trade System (CFETS) in coming weeks.

That indicates the two currencies will be included in the CFETS RMB Index as well, which comprises a basket of currencies the yuan follows and was published by the People’s Bank of China, the country’s central bank, on November 30 last year.

The index debuted at 102.93 six months ago and slid to 96.98 as of May 13, according to latest data from CFETS, while the yuan against the greenback has weakened 2.1 per cent.

Paul Mackel, head of emerging market foreign exchange research at The Hongkong and Shanghai Banking Corporation (HSBC), along with three colleagues, said in a report that daily volatility of the onshore yuan against the US dollar could pick up slightly with such a new basket.

“Even amid more normal market conditions, the daily volatility in the yuan against the US dollar could pick up slightly” after the introduction of the won and rand, the HSBC report said.

Both the won and rand are more volatile currencies which tend to depreciate significantly when the market turns risk averse.

“Their inclusion would dilute the weights of the greenback, euro and yen which are reserve currencies and ‘safe havens’,” the report said.

There are 13 currencies directly trading with the onshore yuan on CFETS currently. They include the

US, Hong Kong, Australian, Canadian, Singaporean and New Zealand dollars as well as the euro, Japanese yen, the Swiss franc, the British pound, the Malaysian ringgit, the Russian rouble and the Thai Baht.

The Korean won could potentially be introduced into the basket with a weight of 11.7 per cent, given China’s significant trade ties with the country. It would then replace the Hong Kong dollar as the fourth-largest component in the basket, following the US dollar, euro, and yen. The rand would have a weight of only 2.4 per cent, the report said.

“It’s likely that the new CFETS Index would show a more rapidly effective appreciation of the yuan amid bouts of market volatility,” the report said. “And if policy markets feel inclined to mitigate this upward pressure on the yuan, they would have to lift onshore yuan per dollar by a larger extent than would be the case currently, given the reduced weight of the US dollar in the new basket.”

Along with a larger and more volatile daily change in the US dollar against the basket, the mid point of the yuan will also show greater movements.

An inclusion of the rand and won, possibly in May or June, will dilute the weight of the US dollar which is on a strengthening path and so reduce the associated effective appreciation of the yuan.

“We do not believe an expansion of the basket is based on an intention to purposely inflate the index’s valuation and thereby create more room for the yuan’s depreciation,” the analysts said. “We also caution against over-thinking about the timing of a change to the basket composition.”

The discussion of direct yuan-won trading onshore was decided as early as February, they said.

“In our view, it is only a matter of time until more currencies trade on the CFETS platform — and thus be included in the yuan basket — as China gradually opens up its financial markets and establishes closer relationships with other central banks.”

The likely inclusion of the won and the rand would raise the coverage of the CFETS basket from 53 per cent of China’s total trade to 62 per cent. There is obviously still room for improvement, HSBC said.