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How PBOC Controls the Yuan (RMB) in the Trade War



A bank clerk counts US currency and Chinese banknotes at a bank in Nantong, Jiangsu Province, China.

Xu Jinbai | Visual China Group | Getty Images

China's yuan is being watched closely as its economy slows and Beijing remains involved in a trade war with the US, which has upset global markets.

The onshore yuan fell to levels unseen since February 2008 on Monday, and the offshore yuan fell to its weakest levels since trading on the international market in 201

0.

Analysts said the recent tightening of trading tensions and investors are asking how far Beijing would allow a weakening of the currency.

Here's how China controls the yuan, also known as the renminbi.

One currency, two exchange rates

Unlike other major currencies, such as the US dollar or the Japanese yen, which have a floating exchange rate, China strictly controls the yuan rate on the mainland.

The People's Bank of China (PBOC) sets every morning a so-called daily average based on the closing level of the yuan the day before and the quotes by Inte R-Bank traders. The central bank also manages China's complex monetary policy.

The currency may trade in a narrow range of 2% above or below the daily mid price. If, in the opinion of some market observers, it goes too far, the Chinese central bank intervenes to buy or sell the yuan, limiting their daily volatility. This exchange rate is referred to as onshore yuan or CNY.

The PBOC, which is heavily influenced by the central government, sets the daily focal point to give direction to the market and guide the currency. The tightly-managed onshore yuan weakened 4% against the dollar this month.

The yuan is also traded outside the mainland, mainly in Hong Kong, but also in Singapore, London and New York. [19659002] Known as the offshore yuan or CNH, the currency is not as tightly controlled as the onshore yuan. Market supply and demand influence the exchange rate of the offshore yuan, but the volume traded is comparatively lower.

How the PBOC affects the offshore yen

The central bank wants to keep the spread between onshore and offshore yuan as low as possible Technically the same currency, experts say.

If the offshore price deviates too far from the onshore price, the central bank will intervene to dampen volatility and support the currency with its huge foreign exchange reserves more than $ 3 trillion from July. The PBOC also relies on state-owned banks to enter the offshore market and exchange dollars for yuan.

In order to prevent the offshore yuan devaluing too quickly, the Chinese central bank in Hong Kong is also issuing short-term notes denominated in yuan depriving the market of substantial liquidity, and increasing the borrowing costs for the yuan, which is the renminbi's short-selling rate elevated.

When traders try to sell the yuan, they predict that its value will weaken against another currency in the euro future. One possibility is to borrow in yuan and pay back at a discount if the value of the currency goes down.

Is there a new, well-monitored onshore level?

China has allowed its currency to weaken beyond a psychologically important level. This has prompted the US Treasury to designate Beijing as a currency manipulator. Subsequently, the PBOC set the yuan's midpoint at a level above 7 for the first time in 11 years on 8 August.

The CFETS RMB index – which measures the yuan against a basket of its competitors – also Tommy Xie, head of Greater China research at OCBC Bank, told CNBC that the market is still trying to reach consensus The next important level for the onshore currency is 7.20 yuan per dollar.

A Hong Kong-based banker told CNBC that the next closely watched level could be at 7.25 and 7.25 Depending on the US-China trade war, it may yet further mitigate, if the levies are further increased.

A weaker currency will cheapen and strengthen the competitiveness of Chinese exports in international markets and could potentially offset some of the impact of tariffs.

It's still unlikely that Beijing will drop the yuan too fast.

This is because it is feared that a rapidly weakening yuan could lead to substantial outflows of capital, where investors outsource their wealth due to perceived instability from a country and prevent their wealth from being written off. There are also concerns about the freezing of credit markets and the tightening of domestic financial conditions, as was the case after the yuan's 2% decline in 2015. Since then, China has taken years to stabilize its capital outflows.

Internationalization Efforts

According to some experts, the internationalization of the yuan has become a high priority for China.

China has accelerated its efforts to internationalize the currency after the global financial crisis, when Beijing introduced the so-called dim-sum bond market – or Yuan-denominated bonds issued outside the mainland – and is eligible for cross-border trade in the renminbi ,

Beijing, for its part, wants more pricing power for key commodities like oil and asset prices like gold. The yuan is set to become the reserve currency, similar to the US dollar.

The status of the dollar in the global financial market allows the US to borrow with impunity without compromising investor sentiment towards US assets, the Hong Kong-based banker. If the yuan became a popular reserve currency, China could potentially take on more debt to better meet its domestic needs.

China, however, is still unwilling to curb fears that massive capital outflows could occur Chinese investors may be able to bring their money abroad and onto the international market.

The yuan was added to the currency basket of the International Monetary Fund in 2016. China continues to track its value against other currencies in the RMB index.

But in the face of an increasingly uncertain trade agreement between the US and China, the yuan's relationship with the dollar continues to be watched closely by investors and economists.

– Reuters contributed to this report


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