Yuan management in the spotlight

The US government’s decision to label China a currency manipulator after Beijing allowed the yuan to weaken past the symbolic 7-per-dollar level has raised questions about how tightly managed the currency is, and its true value. Let’s take a closer look.

How does China manage the yuan?

The People’s Bank of China (PBOC) allows the yuan to trade in a 2% range around a mid-point it fixes against the dollar each day. That point is based on yuan movement in the previous session and moves in currencies of trading partners. China also maintains heavy capital controls, strict foreign investment quotas and a complex system that manages onshore trading and influences offshore yuan activity, leaving the true value open to interpretation.

How has the yuan fared against major currencies?

Since the trade war began in April 2018, the offshore yuan has tumbled 11% versus the US dollar. Last week it hit a record low of 7.1397. Since 2008, the yuan has risen 3.7% versus the dollar and 35% versus the euro but slumped 13% versus the yen.

How has the CFETS basket behaved?

The trade-weighted China Foreign Exchange Trade System (CFETS) yuan index contains 24 currencies, and the dollar’s weight is 22.4%. Many analysts believe Beijing is comfortable with the CFETS index swinging between 92 and 98, making the currency not too weak relative to partners. But last week the index fell to a record low below 92.

Does the PBOC intervene?

China’s central bank rarely intervenes directly in forex markets, usually operating through state-owned banks, in addition to using money market operations and its hefty reserves. The PBOC is also believed to influence offshore markets in various ways, including scheduled and off-cycle sales of yuan-denominated bills in Hong Kong. Such sales soak up liquidity and stem speculative short-selling.

Is the yuan undervalued?

Based on the real effective exchange rate (REER), which measures value against currencies of major trading partners after adjusting for inflation, the yuan is close to if not slightly stronger than its long-run average. At the end of June, the yuan’s REER was 4.9% above its 10-year average and 13.4% above its 15-year average. In comparison, the dollar’s REER was 11.2% above its 10-year average and 10.3% above its 15-year average.