VI. The RMB Exchange-Rate Regime was Improved
During the second quarter, the Foreign Exchange Self-Disciplinary Mechanism led member banks to improve the CNY/USD central parity formation mechanism and introduced the "counter-cyclical factor" into the existing formation mechanism of "closing rate + exchange-rate movements against a basket of currencies," with the aim of offsetting pro-cyclical volatilities due to market sentiments and to alleviate the potential "herding effect" in the foreign exchange market. After the adjustment, the new formation mechanism of "closing rate + exchange-rate movements against a basket of currencies + the counter-cyclical factor" operated in an orderly way and better reflected the fundamentals of the Chinese economy and changes in the international foreign-exchange market. The flexibility of the CNY/USD exchange rate further improved and two-way movements became more obvious. Exchange-rate expectations were generally stable.
During the second quarter, the highest and lowest central parities of the RMB against the US dollar were RMB 6.7744 and RMB 6.9066 respectively. During the 60 trading days, the RMB appreciated on 29 days and depreciated on 31 days. The largest daily appreciation and depreciation were 0.80 percent (543 bps) and 0.25 percent (174 bps) respectively.
The RMB depreciated against the euro, the Japanese yen, and other major currencies. At end-June, the central parities of the RMB against the euro and the Japanese yen stood at RMB 7.7496 per euro and RMB 6.0485 per 100 yen, depreciating 5.71 percent and 1.48 percent respectively from the end of 2016. From the exchange-rate reform in 2005 to end-June 2017, the RMB appreciated by a cumulative 29.22 percent against the euro and a cumulative 20.79 percent against the Japanese yen.
At end-June, under the bilateral currency swap agreements between the PBC and foreign monetary authorities, the latter utilized a total of RMB 22.187 billion and the former used foreign currencies equivalent to USD 1.548 billion. These swap agreements have played a positive role in promoting bilateral trade.
Table 8 The Trading Volume of the RMB against Foreign Currencies in the Inter-bank Foreign Exchange Spot Market during the First Half of 2017
Unit: RMB 100 million
| Currency | USD | EUR | JPY | HKD | GBP | AUD | NZD | SGD | CHF | CAD | MYR | RUB |
| Trading Volume | 192,112.52 | 2,978.8 | 1,727.73 | 1,078.06 | 250.36 | 513.37 | 105.95 | 94.17 | 75.81 | 320.10 | 20.24 | 54.17 |
| Currency | ZAR | KRW | AED | SAR | HUF | PLN | DKK | SEK | NOK | TRY | MXN | |
| Trading Volume | 1.42 | 184.67 | 0.60 | 5.82 | 0.00 | 0.03 | 10.57 | 12.78 | 2.70 | 0.00 | 0.01 |
Source: China Foreign Exchange Trade System
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Box 2 The "Counter-Cyclical Factor" Introduced into the RMB Exchange-Rate Regime by the Foreign Exchange Self-Disciplinary Mechanism
As the market-oriented reform of the RMB exchange rate has been advancing steadily, the central parity of the RMB exchange-rate formation mechanism has improved. On August 11, 2015, the PBC led central parity quoting banks to further improve the formation mechanism of the RMB against the US dollar, indicating that the central parity quoting price shall be decided with reference to the closing price on the previous trading day. On December 11, 2015, the China Foreign Exchange Trade System launched the RMB exchange-rate index, which strengthened the reference to a currency basket to better maintain the stability of the RMB exchange rate against the currencies in the basket. As a result, the CNY/USD central parity formation mechanism of "closing rate + exchange-rate movements of a basket of currencies" was developed. In June 2016, the Foreign Exchange Self-Disciplinary Mechanism was established, allowing financial institutions to play a more important role in maintaining orderly operations in the foreign-exchange market and in an environment for fair competition. The Exchange Rate Working Group was asked to mainly regulate the RMB exchange-rate central parity quoting activities. In February 2017, the Foreign Exchange Self-Disciplinary Mechanism adjusted the reference period for the central parity against the currency basket from 24 hours ahead of submitting the quotes to 15 hours between the closing on the previous trading day and the submission of the quotes, which avoided repeated references to the daily movements of the USD exchange rate in the central parity of the following day. In general, the RMB exchange-rate central parity formation mechanism has been improving, which has effectively improved the rule-based, transparent, and market-oriented nature of RMB exchange-rate policies and has played an active role in stabilizing exchange-rate expectations.
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Since 2017, stabilization of the Chinese economy has been strengthened, with major indicators indicating better-performing trends and an obvious acceleration in the growth rate of exports. At the same time, the US dollar has been weakening, with other major currencies significantly appreciating against the US dollar. From January to May of this year, the euro, the Japanese yen, the British pound, and the Australian dollar appreciated against the US dollar by 6.91 percent, 5.58 percent, 4.46 percent, and 3.08 percent respectively, and some emerging market currencies also appreciated against the US dollar, for example the Russian ruble, the Indian rupee, the Mexican peso, and the South African rand appreciated against the US dollar by 8.31 percent, 5.29 percent, 11.32 percent, and 4.74 percent respectively. During the same period, the Chinese RMB appreciated only 1.07 percent against the US dollar, which does not reflect economic fundamentals and changes in the international foreign-exchange market. One of the important reasons for this is that to some extent there is a pro-cyclicality in the foreign-exchange market, and market participants are easily affected by irrational expectations and they overlook the supporting effects of the economic fundamentals for a better exchange rate. As a result, a one-sided market may be amplified and self-reinforced, thus exacerbating the risk of overshooting market exchange rates. To address this issue, the "Exchange Rate Working Group," led by the ICBC under the Foreign Exchange Self-Disciplinary Mechanism, suggested adjusting the RMB central parity formation mechanism of "closing rate + exchange-rate movements of a basket of currencies" to "closing rate + exchange-rate movements of a basket of currencies + the counter-cyclical factor.” This suggestion was agreed upon by core members of the Foreign Exchange Self-Disciplinary Mechanism and implementation was officially announced by its Secretariat. To calculate the counter-cyclical factor, one begins by removing the impact of the currency basket from the movement between the previous closing rates and the central parity, after which the exchange-rate movements mainly reflect market supply and demand. The counter-cyclical factor can be found by adjusting the counter-cyclical coefficient, which is set by the quoting banks based on changes in the economic fundamentals and the extent of pro-cyclicality in the foreign-exchange market.
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The introduction of the counter-cyclical factor into the central parity formation mechanism has further improved the market-based RMB exchange-rate formation mechanism. First, it helps the central parity better reflect the fundamentals of the macro economy. As described above, there has been a significant discrepancy between the movement of the CNY/USD exchange rate and the economic fundamentals and the international foreign- exchange market. This might imply that under one-sided market expectations, the simple mechanism of "closing rate + exchange-rate movements of a basket of currencies" might cause the central parity to reflect changes in line with the expectations, but few if any changes against the expectations. The introduction of the counter-cyclical factor is helpful to correct this asymmetry. Many market participants also believe that the introduction of the counter-cyclical factor is a very good mathematical way to solve the issue of asymmetric depreciation. Second, it may help offset pro-cyclical volatilities in the foreign-exchange market so that the central parity better reflects reasonable changes in market supply and demand. The exchange rate, as the price of the local currency and the foreign currency, features both goods and assets. The nature of assets means that movements in the exchange rate might trigger investors to buy on the upswing and to sell on the downswing, thus bringing pro-cyclical volatilities to the foreign-exchange market. As a result, a reasonable market supply and demand that is in line with the fundamentals might be distorted and the gap between supply and demand might be amplified. The introduction of the counter-cyclical factor into the central parity formation mechanism can restore market supply and demand to a level that is in line with the economic fundamentals so that market supply and demand can play a more decisive role in the exchange-rate formation and prevent one-sided overshooting of the RMB exchange rate. In fact, the introduction of the counter-cyclical factor will not change the trend or direction in the supply and demand of foreign exchange. A screening of the herding effect on the foreign-exchange market is not against market forces, but rather it is aimed to facilitate the rationality of market activities while respecting the market. Since the irrational factor in foreign-exchange demand and supply has been properly offset, after the introduction of the counter-cyclical factor the central parity formation mechanism has increased the weight of the reference to the currency basket, which may help maintain the stability of the RMB exchange rate against the currency basket and prevent a divergence of expectations. Of course, the increased weight of the reference to the currency basket is not pegged to the basket, and market demand and supply still play a decisive role in exchange-rate movements. Third, the improved central parity formation mechanism has maintained its rule-based nature and a high level of transparency. The rule-based nature and transparency of the benchmark price formation mechanism are decided by the clarity of its rules and its mechanism as well as by the feasibility of verification of the rules and mechanism by the quoting institutions. The adjustment to introduce the counter-cyclical factor into the central parity formation mechanism was proposed by a member of the Foreign Exchange Working Group under the Foreign Exchange Self-Disciplinary Mechanism and implementation was agreed upon after extensive discussions among all fourteen members of the RMB exchange-rate central parity against the US dollar quoting banks. Each member bank provided their quotes based on a thorough understanding of the new mechanism, and they also verified the released central parity based on their own quotes and data from the public. In addition, all the data used for the calculation of the counter-cyclical factor come from public information or from internal data of their own discretion, without interference from third parties. In general, after the introduction of the counter-cyclical factor, the rule-based nature, transparency, and market orientation were further improved.
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From the perspective of actual operations, the new mechanism has effectively contained the herding effect in the foreign-exchange market, enhanced the role of China's macro-economic fundamentals in the formation of the RMB exchange rate, and maintained the basic stabilization of the RMB exchange rate at a reasonable and equilibrium level. On June 30, 2017, the central parity of the RMB exchange rate against the USD was RMB 6.7744 per US dollar, appreciating 2.4 percent from the end of the last year, and the market exchange rate closed at RMB 6.7796 per US dollar, appreciating by 2.51 percent from the end of the last year.
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