IMF set stage for China currency shift
The International Monetary Fund set the stage for Beijing's dramatic currency policy shift this week by warning Chinese authorities in May that it was becoming "increasingly critical" for Beijing to allow its currency to trade more freely, according to an IMF report.
The warning presaged this week's move by the People's Bank of China to allow a greater role for markets in setting the exchange rate of the renminbi and what turned out to be the two biggest daily depreciations of the currency in more than 20 years.
In what the IMF has called a "welcome step", the PBOC this week caught markets by surprise when it abruptly altered the way it sets the daily midpoint for the narrow band in which China has allowed the currency to trade against the US dollar since 2005.
The IMF has for years called for China to allow a greater role for the markets in all of its economic policies. But in their annual assessment of China's economy released on Friday, the IMF's staff wrote that during discussions with Chinese authorities in May they had stressed that it was becoming increasingly urgent for Beijing to act on the exchange rate, which is now allowed to move only in a 2 per cent band around the daily midpoint.
"More flexibility is becoming increasingly critical to move to an effectively floating exchange rate," the IMF economists wrote in a summary of their discussions with Chinese authorities presented to the board last month but only released publicly on Friday.
Because of sizeable and growing capital flows, the IMF said China's monetary policy risked becoming less effective, they said. The "impossible trinity" of a closed capital account, independent monetary policy and a tightly managed exchange rate was set to "become increasingly binding", IMF staff wrote.
China needs to move to something akin to a floating exchange rate within two to three years, they said. But "steps over the next few months could include a further widening of the band and changes to how the central parity is set", the IMF economists wrote. The latter is what the PBOC opted to announce on Tuesday.
Markus Rodlauer, the IMF's mission chief for China, declined to reveal the details of the fund's discussions regarding the exchange rate with Chinese authorities in May. But he said there had been a "meeting of the minds" on the need for markets to play a greater role in setting the value of the renminbi.
This week's step and the subsequent falls in the value of China's currency had not altered the IMF's view announced at the close of the mission in May that the renminbi was "no longer undervalued", said Mr Rodlauer, although he declined to call it "fairly valued". Since 2005 the renminbi has appreciated more than 30 per cent against the US dollar, according to the IMF, while this week's falls amounted to less than 3 per cent.
But they had marked a significant step towards a freer exchange rate, he said. Under the new rules the PBOC's daily midpoint, around which the 2 per cent trading band is set, will be linked to the previous day's closing value. Theoretically that means the renminbi could trade up or down as much as 10 per cent in any given week, Mr Rodlauer said.
"That does bring us quite close to a float," he said. Moreover, he said he expected the band to widen in the coming years as China continues to move towards a freely floating exchange rate.