August 10, 2005

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Yuan and Chinese financial market reforms

China has announced the composite currencies in its new reference basket in managing the yuan. The major currencies are the US dollar, Euro, yen and Korean won. Smaller members of the basket are the Singapore dollar, British pound, Malaysian ringgit, Russian rouble, Australian dollar, Thai baht and Canadian dollar. As expected, the weightings are based on foreign trade flows, which means the US dollar will continue to dominate the basket.

Did you spot the obvious omissions? No New Taiwan dollars, and no Hong Kong dollars.

At the same time the PBoC have liberalised financial markets, allowing more participants in the spot forex market, introducing interbank forex forwards and allowed the trading of yuan swaps. Below the fold is a Reuters article on these changes. But at the same time, the PBoC announced it is tightening its supervision to ensure a "stable, orderly market". Liberalising with one hand, but tighter supervision with the other. How can you tighten supervision when previously the market was Government controlled or banned?

Here's PBoC Governor Zhou on the RMB reforms.

Meanwhile, 3 of China's biggest securities brokers received RMB1.45 billion in soft loans as part of the ongoing bail-out of the sector.

Update (18:00) A bit of research reveals if the basket weights are based on the currency trade is denominated in, the US dollar weight should be around 52%, Euro 15%, Yen 13%, Won 8 and the others all around 2%.

Other Reading

Sun Bin discusses the RMB peg mechanism and some thoughts on its implications.
Logan Wright intends to follow the "actual" movement of the basket and says PBoC aren't following the Signaporean basket model.
Dan Drezner has some of an FT article on the moves.
Brad Sester isn't impressed by the new RMB forwards market.
Macroblog says the reforms are another step forward.

00:37 10Aug2005 RTRS-CORRECTED - UPDATE 2-China expands yuan forward market

In BEIJING story UPDATE 2-China, in new reform, permits yuan forward market, please read in headline ... "China, in new reform, expands yuan forward market" ... instead of ... "China, in new reform, permits yuan forward market".
Please make conform throughout to show China has expanded the existing market for retail yuan forwards, and has launched yuan swaps, but has not launched an interbank forwards market.

(A corrected story follows.)
(Adds reaction)
By Selina Shao
BEIJING, Aug 9 (Reuters) - China said on Tuesday more banks would be allowed to trade yuan forwards, a liberalisation move driven by the scrapping of the currency's 11-year-old peg to the dollar.
The long-awaited announcement by the People's Bank of China will make it easier for companies to hedge increased risks they face following Beijing's decision on July 21 to abolish the dollar peg and let the yuan trade a bit more freely.
The central bank, in a statement on its Web site, also announced the launch of trading in yuan currency swaps.
"It's just another step down the path of modernising the domestic financial system. I don't think there's any particular implication for the dollar/yuan rate or for the prospect of further revaluation," said Adrian Foster, head of currency strategy at Dresdner Kleinwort Wasserstein in London.
Forwards allow a company or bank to lock in an exchange rate for a foreign currency payment at a specified future date. A swap is another tool for hedging against -- or betting on -- moves in exchange rates or interest rates.
The central bank said forwards trading would be expanded to all banks, including foreign-owned banks, that have licenses to settle foreign exchange deals and to trade derivatives.
Until now, only four state-owned commercial banks and three joint-stock banks had been allowed to transact forwards with clients who could prove a need to hedge for trade purposes.
"Obviously you give more room for the market to exercise its view, and obviously it expects the renminbi to appreciate further," said Fong Cheng Hong, head of market research at DBS in Singapore.
The forwards market has been carefully guided by the central bank, and banks have been unable to set off their exposures with other banks.
A central bank spokesman clarified that the announcement did not signal the launch of an interbank forwards market. "This covers services that banks provide to companies," he said.
But the statement said that banks would now be allowed to set forward rates independently and that banks would be allowed to draw up forwards contracts for all their customers' current account transactions and for some capital account items.

Since ending the yuan's dollar peg, Beijing has emphasised the importance of developing China's fledgling foreign exchange market so it can better reflect supply and demand.
Last week Beijing announced that companies would be permitted to retain more of their foreign exchange earnings rather than being obliged to change them into yuan.
Another step expected soon is approval of a system of market makers for dollar/yuan trading, which is presently dominated by the central bank.
Until last year China had banned the creation of derivatives because of a series of price-rigging scandals in the mid-1990s that prompted worries about risk and a lack of market rules.
Despite the latest reforms, China's foreign exchange market remains strictly controlled.
Most currency transactions are prohibited unless they are for trade and approved investment purposes, permitting the central bank to keep a tight grip on the yuan thanks to its oversight of the China Foreign Exchange Trading System, the country's market for currency trading and clearing based in Shanghai.
"The move will be good for the further development of the local forex market," a trader with Bank of China said of the expanded forwards market.
But she said it might not have much of an impact on exchange rates, given the central bank's eagle eye. "Foreign players might be deterred if they see little to be gained from joining the game," she added.
Because of the restrictions on onshore trading, an offshore non-deliverable forwards market has developed, centred in Singapore, that allows investors and companies to bet on the future direction of the yuan. The contracts are settled in dollars. Turnover in the market is around $500 million a day.
(Additional reporting by Fang Yan and Jerker Hellstrom in Shanghai and Katie Hunt in London)
((Writing by Alan Wheatley, editing by Malcolm Whittaker;; Reuters Messaging:; +8610 6586 5566 x235))

posted by Simon on 08.10.05 at 12:13 PM in the China economy category.


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It may make sense to leave out HKD due to the peg. The TWD? Perhaps it's in there but they aren't saying. Though there are arguments that this isn't really a proper trade-weighted basket, and that USD remains the anchor, in which case a TWD component wouldn't make too much difference.

posted by: myrick on 08.10.05 at 07:38 PM [permalink]

The only reason you'd add the Hong Kong Dollar to the basket is if you expected HKD to be un-pegged from the US Dollar any time soon. I don't think anyone is predicting that to happen, even Beijing.

posted by: Beau on 08.11.05 at 05:35 AM [permalink]

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