Suspicion About PBoC FX Policy Shift

26 Jul 2018

‘m not in the business of changing policies. I hope to inform, not form, decisions – Dalia Mogahed

Trade conflicts are risking another round of currency war.  Suspicion about China’s central bank shifting to a currency devaluation policy to fight the trade war with the US has intensified since June as the Sino-US trade tension has escalated.  Indeed, when US President Donald Trump criticised China (and Europe) on 19 and 20 July for manipulating their currencies to gain competitive advantages, the PBoC set the CNY-USD fixing on 20 July almost one percent lower than the previous closing.

Let us test the devaluation proposition by examining the PBoC’s action through the fixing.  There are three parts to the renminbi fixing:

  1. The CNY-USD’s spot closing rate as of 4:30pm of the previous trading day.
  2. The average of the 24-hour daily changes in the USD against the currencies in the CFETS basket, the BIS CNY basket and the IMF SDR basket.
  3. A “Countercyclical Factor” which represents the PBoC’s discretion in adjusting the fixing based on its judgement on the FX market’s demand and supply conditions, risk appetite and international developments.

The third part of the fixing was always there but was formalised as a Countercyclical Factor (CF) in May 2017 for Beijing to manage FX volatility that is not reflected by economic fundamentals.  The first two parts are market forces that drive the renminbi’s movement; the CF is a policy factor that holds the clue to assessing whether the PBoC engages in devaluation or not.


Estimating the countercyclical factor

The first two parts of the fixing are observable, but the PBoC has never disclosed its calculation of the CF.  We can estimate it by making the following observations and assumptions:

The fixing is determined by 1) market forces as reflected by the previous day’s (denoted as “t-1” below) closing of the CNY-USD cross-rate and average change of the currency baskets monitored by the PBoC and 2) the CF on the day (denoted as “t” below) when the fixing is set.  If we assume that the first two factors carry equal weights in the fixing calculation, this implies:

PBoC Fixingt = average DoD% of (CNY-USD)t-1 and (CFETS, BIS, SDR)t-1 + CFt

The only unknown here is the CF.  We can do a back-calculation to estimate the CF by subtracting the implied CNY-USD cross-rate calculated from the previous day’s closing of CNY-USD and the average change of the currency baskets from the PBoC’s fixing:

CFt = PBoC Fixingt – {average DoD% of (CNY-USD)t-1 and (CFETS, BIS, SDR)t-1}


What does the estimated CF mean?

If the CF is negative, it means that the PBoC is using the CF to force the fixing to go against the market trend, though not necessarily overwhelming and reversing it.  For example, according to the data, market forces implied a CNY-USD cross-rate of 6.855 on 20 July 2018, but the PBoC set the fixing at 6.759 that morning, or 0.095 stronger than what market forces would warrant (6.759 – 6.855 = -0.095).  Conversely, if the CF is positive, the PBoC is using it to lead market forces, thus discerning a policy of pushing the currency along the market direction but weaker than market forces would imply.

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