China is considering introducing a countercyclical factor to adjust the way it calculates the yuan’s daily reference rate against the dollar, according to a statement by the country’s foreign exchange trading system on Friday. Analysts said the move will help prevent excessive fluctuation of the currency.
The change in the method of setting the yuan’s daily central parity rate against the dollar will better reflect the market supply and demand, lessen possible herd effects in the market and help guide the market to focus more on macroeconomic fundamentals, the China Foreign Exchange Trade System said.
China’s foreign exchange market is prone to the habitual influences of irrational expectations and one-way market expectations can sometimes be exaggerated, failing to reflect the real relationship between market supply and demand, the statement said.
Although the US dollar index value has dropped sharply in recent weeks and China’s economic fundamentals have improved significantly, the yuan’s central parity rate, based on the existing rate-setting mechanism, has shown trends of depreciation that do not reflect the real economic fundamentals, the system said.
It did not elaborate on the technical details of how the countercyclical factor will be determined.
The main role of the factor will be redressing the abnormal changes in the foreign exchange rate of the yuan due to irrational market sentiment, said Chen Jianheng, an analyst at China International Capital Corp.
As seen in the yuan’s rate against the dollar since April, the deviation between the yuan’s closing rate and its central parity rate has been widening, with the closing rate most of the time weaker, said Chen. The introduction of the ‘countercyclical factor’ will help reduce that deviation.
Analysts also said China is entitled to make adjustments to the methodology of setting the yuan’s reference rate.
The move is understandable since China has adopted a managed floating exchange rate system, said Liu Dongliang, an analyst at China Merchants Securities. Against that backdrop, any technical adjustment is normal.