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FXPRIMUS Market Brief of the Week: Widening Yuan's Trading Band Does Not Make a Difference

SINGAPORE, SINGAPORE -- (Marketwired) -- 03/18/14 -- In FXPRIMUS' Market Brief of The Week for 17 March, the brokerage firm's Senior Economist, Jimmy Zhu, looks at China's effort to revive the Yuan.

Economic Insights

The People's Bank of China (PBOC) Widened Yuan's Daily Trading Band from 1% to 2%

China's central bank widened Yuan's trading band against the Greenback, a move that signaled its process in the reform agenda. The PBOC announced that Yuan's daily trading band against Dollar would be widened to 2%, up from the earlier 1% effective today.

A wider trading band promises to introduce greater volatility into an exchange rate where movements have been modest when compared to other major currencies. The focus is to discourage one-way bets on Yuan's appreciation, which was previously one of the safest bets in major currency markets. The "wish" is that a market price for a key macro-economic variable will encourage greater efficiency. From the chart below, we can see that the USDCNY 1-month vols surged since February this year, when Yuan suddenly encountered a sharp selling off.

USDCNY 1-month vols (white) vs. USDCNY (yellow)

To view the figure accompanying this press release, please visit the following link:

http://media3.marketwire.com/docs/933957.jpg

By reducing the value of currency and interest rates, it also helps to trim shadow banking activities. Two-way fluctuations could unwind speculative inflow positions and give the central bank greater scope to set an independent monetary policy. One of the main reasons for the PBOC to engineer exchange rate lower is to decelerate shadow finance activities and keep its financial market stable for a longer period of time. Lots of the hot money is purely betting the RMB's one way move. Once this perception is eliminated, the amount of the inflow will be trimmed substantially. Lower rates will also push those wealth management products' (WMP) yield lower. Numbers of Alibaba's Yuebao accounts reached 81 million, much higher than the numbers of the A share account holders at 67 million. With the benchmark interest rates moved lower, Yuebao's annual yield dropped below 6% this week, reducing its popularity. Some of the supply will also be cut from here.

But, the key issue here is: will that make any significant differences? From our point of view, we do not think it will. PBOC said exactly the same thing in April 2012 when it last doubled Yuan's trading band. But volatilities did not move higher, instead they gradually edged lower.

USDCNY volatilities in 2012 & 2013

To view the second figure accompanying this press release, please visit the following link:

http://media3.marketwire.com/docs/933957A.jpg

Other major currencies were trading without constraints, such as the Euro. They rarely rise or fall by more than 1% against the Dollar in a day, or less than 5% in a year. So, China's widening of the RMB's daily range to 2%is a very symbolic move. Let us be realistic, the Yuan's value remains in the hands of policy makers.

The PBOC may lower the bank's reserve requirement ratio in order to boost lending and revive economic growth. The economy may need some support if it is going to meet the government's 7.5% expansion target due to the Yuan's record of 1.3% YTD fall, a declining Purchasing Managers' Index (PMI) and an 18% plunge in exports last month. Lowering reserve requirement ratio is one of the few policy options that the central bank has left amid liberalisation of interest rates.

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