Reference Currency Basket of the Renminbi

inSight

01 Sep 2005

Reference Currency Basket of the Renminbi

The People’s Bank of China is right in taking a gradual approach in releasing further information about the new renminbi exchange rate regime.

The disclosure of the composition, although not the weightings, of the reference currency basket for the determination of the renminbi exchange rate is a courageous step by the Mainland authorities. It is a demonstration of confidence in monetary management, as the People’s Bank of China (PBoC) makes impressive progress in the reform and liberalisation of the Mainland monetary system. There are quite a few jurisdictions operating with a currency basket, whether it is used for reference or as an anchor, and the composition of the basket is, more often than not, kept confidential.

It is always very difficult to strike the right balance, particularly in exchange rate management, between withholding key information, for the purpose of retaining some constructive ambiguity on the one hand, and transparency that theoretically enhances efficiency and credibility on the other. As we are all aware, financial market behaviour is never easy to predict and it has become increasingly less so with globalisation. Much as we would like to promote the operation of free market with full transparency, in order to achieve the highest efficiency in price discovery and allocation of scarce resources, the free market does not always give priority to public interest. It is indeed advisable to keep something up our sleeves, whether it is key information or the right to change the rules of the game.

There are other areas of the renminbi exchange rate regime in which information disclosure may similarly be rather delicate. It will be interesting to observe how information disclosure is handled by the PBoC, following the encouraging comment by Governor Zhou Xiaochuan on 29 July 2005. While supporting transparency, he wisely pointed to the need to consider the ability of the public and the market to digest and absorb the relevant information, and advocated gradualism in its release. I fully support this approach. Meanwhile, I am sure second guessing the PBoC will become a popular pastime of observers, whether they have an academic or market or political interest in the renminbi exchange rate regime, and PBoC watching (like Fed watching) will become the career of many in the financial world.

We closely monitor the renminbi exchange rate, for the obvious reason that the reform of the renminbi exchange rate regime will present us with challenges in managing the monetary system of an economy that is so closely integrated with the Mainland. Fortunately, our lines to the PBoC are kept open to ensure that we can carry out our responsibility for monetary stability in the best interests of Hong Kong.

Currently, the focus of market attention seems to be on a number of issues.

  • First, the details of the currency basket reference; for example, how frequently are references made, what is the nature of those references (directional or quantitative) and what is the action plan associated with those references?

  • Second, the actual weightings of the currencies in the basket; no doubt for the purpose of tracking the extent to which the actual exchange rate deviates from the imputed exchange rate if the renminbi were fixed against, rather than determined with reference to, the basket.

  • Third, whether there is a band within which the actual exchange rate is allowed to deviate from the imputed exchange rate and what happens if one of the limits defined by the band is reached.

  • Fourth, whether there is a transitory operational cap for the daily fluctuation in the exchange rate that is smaller than the announced maximum daily fluctuation of plus or minus 0.3%, given that the largest daily movement seen so far is 60 pips or 0.07% on 11 August.

  • Fifth, the degree of autonomy that the PBoC has in determining the daily movement and the cumulative movement over a period of time.

  • Sixth, the set of circumstances in which changes to the exchange rate band may be contemplated.

  • Seventh, how references are made to market supply and demand in determining the exchange rate.

  • Eighth, whether, in the context of referring to market supply and demand, there is a cap for the rate of further accumulation of foreign reserves.

  • Ninth, the relative importance of the two references – the basket and market supply and demand – in the determination of the exchange rate.

  • Tenth, the extent of involvement of the PBoC, if any, in determining the forward exchange rate and making a market for renminbi forwards.

I can probably think of twenty more of such questions, but I am not pressing for any answers. It is up to the PBoC, having regard to the public interest, to decide whether the relevant information should be disclosed.

 

Joseph Yam

1 September 2005

 

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Last revision date : 01 September 2005