China's mysterious new yuan formula 'no big quick fix for market volatility'

Wendy Wu

The Chinese central bank's plans to tweak the way it sets the yuan's daily reference rate to the US dollar points to concerns in Beijing about keeping a lid on market volatility, analysts say.

Zhang Peng | LightRocket | Getty Images

The People's Bank of China (PBOC) confirmed on Friday that it might add a vague "counter-cyclical factor" to the pricing model it offers to market makers to decide the yuan's daily reference rate against the greenback.

The change would mean a stronger state hand and less of a role for market forces in setting the rate.

The PBOC has fine-tuned the pricing mode in the last couple of years by taking reference to the yuan-dollar closing price and the yuan's value against a basket of currencies.

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But the China Foreign Exchange Trade System said the mainland's foreign exchange market was susceptible to "irrational expectations" that could exaggerate one-sided sentiment.

A "countercyclical" factor in the pricing model could help offset the "herd effect" and bring the yuan's central parity in line with economic fundamentals, it said.

Christopher Balding, associate professor at Peking University's HSBC Business School in Shenzhen, questioned the need for the change given the yuan's extremely low volatility in recent months.

"The only logical explanation for the change is that they are trying to provide greater discretion in managing the yuan's value," Balding said.

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No details about the factor have been made public, but it runs counter to Beijing's position of letting the market determine the yuan's value. Balding said the new factor would reduce the yuan's transparency.

Gavekal Dragonomics economist Chen Long said: "The decision may institutionalize the authority's window guidance to fix the yuan rate."

Despite the yuan's recent stability, the currency could confront a higher US dollar as the US Federal Reserve raises interest rates and scales back asset holdings.

Minsheng Securities foreign exchange analyst Zhang Yu said the new factor might be part of an attempt by the central bank to ward off external shocks as well as signal a shift in policy focus from a flexible yuan to domestic financial regulation.

But economists said the new factor would not make a big change to the central parity level.

"The central bank is worried that a persistent weaker spot rate than central parity will trigger depreciation sentiment in the market," one trader with a big-four bank said.

"The tweak may indicate that PBOC is worried about the possible impact on the yuan by the US dollar under US President Donald Trump's administration. But the tweak can't help the authority manipulate market volatility."