China exchange rate regime is unique and a category on its own. The reason being is that China has two different currencies, CNY and CNH. The offshore renminbi (CNH), was developed in July 2010 so that China could gain a significant role in the global FX market and make it an important reserve currency like EUR and USD. CNY was not possible to achieve the goal mentioned above because it is a currency subject to a “managed float” band of 2% from midpoint that is allowed to fluctuate. In more general terms, it is a currency that suffers much intervention from the PBOC.
Furthermore, by having an offshore currency it may not affect its capital account balance at a time that China began to open up its economy and internationalize its currency. As a result, foreign entities and individuals were allowed by the introduction of CNH to hold that currency for any purpose such as foreign direct investments or speculation. It is important to mention China foreign exchange reserves were close to $1 tn in 2007 and climbed to $4 tn in 2014. This shows in numbers the important role that the Chinese currency has in global markets the recent few years.
A worrying statistic for the Bank of China is that these reserves have been steadily declining since 2014, accounting a little more than $3 tn at the moment.
Traders are interested to know what are the factors that affect the CNH. This report will try to address this issue.
One may wonder why everyone pays attention to the international reserves of China. The graph below will show the relationship between the spot CNH price and the reserves of China.
As we can see in the graph, when the reserves decrease the spot USDCNH increases as well, something which suggests that Yuan depreciates. It is suggested by many that the running down of reserves show the size of intervention by the Bank of China in the FX market in order to fulfill its goals. At the moment investors seem to have bearish bets on CNH and PBOC is selling reserves in order to slow down the renminbi’s slide.
One main goal of China to keep on expanding its GDP at a rate above 7%. The best way to achieve this is by increasing its exports around the world. As a result, a weakened CNH makes Chinese goods more attractive to overseas importers of goods. However, even though a weakened CNH may provides benefits to the economy, potentially uncontrollable depreciation of the currency may be really dangerous if we reference back in history such as East Asian financial crisis in 1997, and that is another reason for PBOC intervention.
Another factor responsible for changes in the value of CNH is the persistent strengthening of the dollar which is the main trading partner of Yuan. On July 2014, US Dollar Index stood at 79.8 and now trades at 101.9. The election of Donald Trump as US president supported this trend. USD is a competitor of CNH in the battle of reserve currency and a growing demand for USD steals from the demand of renminbi something which leads to capital outflows from China.
Deposit rates or the Hong Kong interbank borrowing rate is a way to manipulate CNH. The higher the Hibor, the costlier it is to short China’s currency. So when Hibor is high, demand for the currency strengthens and deter bets on renminbi depreciation. Many may wonder why the Hong Kong deposit rate affects the CNH. It should be noted that CNH main market is in Hong Kong and renminbi deposits were allowed there as well. Bank of China (Hong Kong) was designated as the sole offshore renminbi clearing bank since 2004.
CNH has been very volatile lately. The graph below shows the flatness of USDCNH before the storm of the 4th of January which led to a sharp appreciation of the currency and later whipsawed. The future is unpredictable but one thing may be sure: Volatility is here to stay!
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