FX International Payments
By Frances Coppola
Currently, China's domestic, "onshore" currency (CNY) does not float freely against other currencies. The CNY is pegged to the US dollar with a fluctuation band of plus/minus 2 percent. The centre of the band is reset each day by the PBoC, which buys and sells currencies to maintain the CNY within the band.
As part of China’s efforts to internationalise its currency, an “offshore” yuan (CNH) was introduced, traded by the Bank of China through Hong Kong. The CNH floats freely against other world currencies. Observers can see the extent to which Chinese officials control the currency environment by following the difference between the CNY and CNH exchange rates.i
Many analysts believe that China maintains the CNY at too low an exchange rate to benefit Chinese exporters at the expense of exporters from other countries. But in the past year, the opposite has been observed: the CNY’s Real Effective Exchange Rate (REER) has risen by 13%, and the midpoint of the CNY trading band has been persistently above the CNH rate. In a statement at the time of the August 2015 devaluation, the PBoC explained that the central bank fixing point was nearly two percent above the offshore exchange rate and needed to be brought back into line.ii
The PBoC said that in the future, the daily fix would take account of market currency rates. If true, such an adjustment would narrow the gap between the CNY and the CNH, possibly making further sharp devaluations unnecessary. But according to Khoon Goh, a Singapore-based strategist at ANZ Banking Group quoted in Bloomberg, "the one-off devaluation of the fix and allowing more market-based determination takes us into a new currency regime".iii
As the CNY and the CNH continue to move closer together, the need for a separate offshore currency could slowly decline. The IMF is expected to include the CNY in its SDR basket, paving the way for it eventually to become a global reserve currency.
However, many analysts believe that liberalising the CNY will mean further devaluation down the road if the CNH continues to weaken, and that authorities could also tighten capital controls.
Businesses exporting to China could see terms of trade worsen if CNY falls. Conversely, businesses importing goods and services from China may benefit from a falling CNY.
Currency fluctuations are a common risk for businesses in the import and export industry.
Forward Contracts can help businesses manage their foreign exchange risk. Forward Contracts are agreements between businesses and foreign exchange providers to buy or sell foreign currency at a fixed rate of exchange at a future date. They allow businesses to lock in an exchange rate now to avoid currency fluctuations and gain flexibility when business circumstances change.
And watch this short video for a look at the key indicators you need to be aware of and when to watch for them.
With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.