Review of the CFETS Index

Transcription

1 Review of the CFETS Index 1. Introduction News from the China Advisory Division (June ) Tomoko Washiashi China Treasury Division Mizuho Bank (China), Ltd. tomoko.washiashi@mizuho-cb.com On December 11, 2015, a new CNY index, called the CFETS Index, was added to the China Foreign Exchange Trade System (CFETS), which is administered by the People s Bank of China. This article will delve into the background regarding why the Chinese monetary authorities decided to conceive of the CFETS Index, and will also provide information on the impact that this index will have on the Chinese yuan foreign exchange rate. 2. What is the CFETS Index? Three indices have been added to the China Foreign Exchange Trade System: the CFETS Index (a new underlying index), a CNY rate index based on the reference index using the Bank for International Settlements (BIS) currency basket, and a CNY rate index based on the IMF Special Drawing Rights (SDR) currency basket. These three indices all use the level as of the end of 2014 as their standard (100). The index as of the end of November 2015 was announced in December 2015, and the three indices all recorded positive growth compared to the level seen at the end of 2014, at 2.93%, 3.5%, and 1.56% respectively. The weight for each currency used for the three indices was also released. The CFETS Index is an index based on the fluctuation of the Chinese yuan foreign exchange rate against all 13 currencies approved for Chinese yuan transactions using the trade weight for each currency, also giving consideration to intermediary trade (see Fig.1). This index is characteristic in that Korea is not included as of May, despite the fact that Korea ranks high in terms of trade volume. The Korean won is a so-called restricted currency and therefore cannot be traded in the offshore market. On the contrary, the basket includes the currencies of Canada, Switzerland, and New Zealand, which all rank low in terms of trade volume. Given that these currencies can be traded in the CFETS, it is extremely interesting to mention that operations based on the currency basket would be possible through the CFETS. It is also important to follow changes in the currencies included in the basket, as the Korean won, for example, is likely to be included in the basket in the times ahead, according to a media report. In addition, the Bank for International Settlements (BIS) Index is an index that shows the fluctuation of the Chinese yuan exchange rate using the weights of 40 currencies conventionally used by the Bank for International Settlements to calculate the effective exchange rate for the Chinese yuan. The SDR Index is an index that shows the fluctuation of the Chinese yuan using the weights of the existing four SDR basket currencies (see Fig.2 and Fig.3, respectively). 1

2 Fig.1: CFETS Index Lists of currencies used for currency baskets for the three indices Fig.2: BIS Currency Basket (Only the top 13 currencies) Fig.3: SDR Currency basket CFETS Index Compiled based on the website of the People s Bank of China 3. Objective of creating the CFETS Index What does the CFETS Index mean? What does the People s Bank of China intend to do? Let s examine the public statement released on December 14, 2015 by a special reporter for China Money on the website of the People s Bank of China. 1 In this statement, the market mechanism used to determine the Chinese yuan foreign exchange rate shifted to a controlled floating exchange rate system that is adjusted in relation to a currency basket based on the supply & demand balance in the market as a result of the reform carried out on July 21, It says that since then the exchange market was operated under this discipline for the majority of the time except for a certain period in which the control was strengthened. It was pointed out that market participants have been focusing too much on the Chinese yuan exchange market against the U.S. dollar based on which evaluation and various actions took place. The statement emphasized that such attitude can be seen in the fact that some market participants expect the Chinese yuan to depreciate as a result of the release of the CFETS Index in December Thus, the report underlines that market participants should start using the currency basket as reference information rather than focusing too much on the exchange rate against the U.S. dollar. Deputy Governor of the People s Bank of China Yi Gang also emphasized at a press conference held in December 2015 that the market currently has a controlled floating system with a reference of a currency basket based on the demand & supply in the market and that this system will continue in the times ahead while reforming the market within that framework. For example, if the euro depreciates significantly against the U.S. dollar in the future, the Chinese yuan exchange rate against the U.S. dollar would be expected to depreciate as well, following the basket currencies. What the People s Bank of China is emphasizing is that this should not be considered to be a depreciation of the Chinese yuan, but it is important to see the fluctuation in relation to the currency basket. Thus,

3 if the CFETS Index is stable, then we should consider this to mean that the Chinese yuan has been stable relative to the currency basket. Fig.4: U.S. dollar/chinese yuan trading exchange market (in black) and the People s Bank of China central parity rate (against the U.S. dollar), since 2005 Source: Bloomberg 4. What is the nominal effective exchange rate that measures the general value of a currency, not that against the U.S. dollar? It is now important to discuss what the nominal effective exchange rate (NEER) is. The NEER is an index that shows how much the value of a currency in a given country has been fluctuating against the currencies of other countries. The index is calculated with a weighted average using the trade volume with a trade partner, which allows us to understand the value of a currency in a comprehensive manner, not only against the U.S. dollar. The latest NEERs for the Chinese yuan/euro/japanese yen are shown below (Fig.5). Since the end of 2014, the depreciation of the Chinese yuan against the U.S. dollar has been gathering public attention. However, if we look at the NEER, the Chinese yuan has actually appreciated against the euro and the Japanese yen. This means that the People s Bank of China has an intention to emphasize that the Chinese yuan should be evaluated not only against the U.S. dollar but also against other major currencies such as the euro and the Japanese yen. This can be seen from a remark made by an official related to the International Monetary Fund (IMF) made in May 2015: We can no longer say that the Chinese yuan has been undervalued given the significant appreciation of the effective exchange rate in the past year. 3

4 Fig.5: Nominal effective exchange rate (NEER) for the Chinese yuan (in blue), the euro (in red), and the Japanese yen (in green), since 2005 Source: Bloomberg 5. The impact of major currencies on the index In his speech made immediately after the Chinese yuan moved to a controlled floating exchange rate system in July 2005, Governor of the People s Bank of China Zhou Xiaochuan listed the U.S. dollar, the euro, the Japanese yen, and the Korean won as the major currencies in the basket. However, the CFETS Index does not include the Korean won. The weights of the currencies in the three baskets that were introduced this time also shows (see Fig.1-3) that the total of the SDR currencies, the U.S. dollar, the euro, the Japanese yen, and the U.K. pound, accounts for the majority for all three indices. As there are other currencies that follow the trends in the U.S. dollar and the euro exchange markets, such as the Hong Kong dollar, which follows the trends in the U.S. dollar exchange market, it can be said that all three indices generally follow the trends for these four currencies. Even though there are different currencies in the baskets for the three indices that were introduced this time, the three indices are expected to remain at similar levels following the trends in the above three currencies. It will thus be possible to expect the evaluation for the Chinese yuan as a stable currency against the currency baskets. 6. Relation between the People s Bank of China central parity rate and the CFETS Index The CFETS Index and the People s Bank of China central parity rate (against the U.S. dollar) since the introduction of the CFETS Index are shown below in Fig.6. When the CFETS Index was introduced in December 2015, market participants considered this a measure to lead the Chinese yuan to depreciate. As a result, the Chinese yuan depreciated by more than 2% from CNY 6.40 to the CNY 6.55 level in a little more than a month from December 2015 to early January. In reaction to this, the chief economist of the People s Bank of China, Ma Jun, released a comment on the website of the People s Bank of China on January 11,. 2 Ma Jun explained that some market participants had been trying to read the intention of the People s Bank of China, having noticed some changes in the People s Bank of China central parity rate since the previous day. Furthermore, he emphasized that the People s Bank of China central parity rate (against the U.S. dollar) is set 2 4

5 based on various factors, including the closing rate of the previous day, as well as on the fluctuation of the currency basket, and that market participants should pay attention to the central rate, the closing rate of the previous day, and the fluctuation of the currency basket. He thus underlined once again that the Chinese yuan exchange rate should not be pegged to the U.S dollar, as it will be more linked to the currency basket in the times ahead. At the same time, he also said that the People s Bank of China would control the fluctuation band of the Chinese yuan in an appropriate manner. He warned that if the Chinese yuan is pegged to a single other currency, there are risks for the trade competitiveness of China to fluctuate violently, creating imbalance in the international balance of payment, while activating arbitrage. After the comment of Ma Jun was added to the website, and as was pointed out by Ma Jun, there has been a trend in which the People s Bank of China central parity rate (against the U.S. dollar) is set toward a stronger Chinese yuan when the Chinese yuan depreciates in the CFETS Index, in order to keep the value of the Chinese yuan stable in the currency basket. Fig.6: CFETS Index (in blue) and the People s Bank of China central parity rate (against the U.S. dollar) (in red) 2015/11/30= High Value of the Chinese yuan Low Dec Jan. Feb. Mar. Apr. Source: Bloomberg 7. Monthly report regarding the CFETS Index Since the comment by Ma Jun, the People s Bank of China has been releasing a report regarding the movement of the CFETS Index in the previous months at the beginning of each month, on its website. In the report, the closing rates of the CFETS Indices of the month (three indices, including the BIS and SDR) are compared with those at the end of the previous month, while also showing the trend in the CFETS indices of the month itself. The latest report for April (displayed on May 6) has pointed out that the upward pressure on the Chinese yuan has been strengthened as a result of the depreciation of the U.S. dollar index, with fading expectation for the interest rate hike in the U.S. However, it was also pointed out that it is impossible for the Chinese yuan to either continue appreciating or depreciating one-sidedly, as the Chinese yuan has been sold based on the Go Out policy, 3 making it desirable for the CFETS Index to remain stable. What has been repeated in the past three comments is the stability of the Chinese yuan in relation to the currency basket. This also shows that the Chinese monetary authorities have been managing the Chinese yuan exchange market while considering the trends in other major currencies apart from the U.S. dollar. 3 This refers to foreign investment mainly by Chinese companies. 5

6 8. The CFETS Index and the Chinese yuan exchange rate Given the above points, it is likely that the Chinese monetary authority has accepted the fact that the Chinese yuan has been depreciating in terms of the effective exchange rate, as the latest CFETS Index has shown a downward trend for the Chinese yuan for a substantial time, while market participants expect the Chinese yuan to be internationalized after being included in the SDR currency basket at the end of November last year. It has been almost half a year since the introduction of the CFETS Index. As the fluctuation of the major currency exchange markets was particularly violent from the end of April toward early May, the close link observed after January between the People s Bank of China central parity rate and the CFETS Index has been clearly fading. Therefore, in the times ahead, market participants should pay attention to this link and to remarks made by important officials related to both sets of data. 9. Conclusion Since 2015, the Chinese yuan has been facing a turning point. From October this year, the Chinese yuan will be included as part of the basket currencies and will be used as a reference in calculating SDR exchange rates and interest rates. Thus, if any new issue arises regarding the internationalization of the Chinese yuan, it has to be resolved this year. The Chinese yuan has been gathering much more significant attention in the market since last year, and market participants should keep an eye out for any news related to the Chinese yuan this year as well. Caution 1. Legal or accounting advice: The information included in this material does not contain any advice on respective professional advisors. 2. Confidentiality: The information included in this material is disclosed to you on the premise of your confidentiality obligation, and should be used for internal purposes only. Disclosure of the contents herein to a third party is prohibited. 3. Copyright: Copyright of the information included in this material belongs to the bank, in principle. You are prohibited to make a copy of, make a reproduction of, quote, reprint, translate, loan, or in any way exploit the content of this material in part or in whole, by any means, for any purpose, without our permission. 4. Indemnity: The information included in this material is obtained from various sources that the bank believes are reliable. However, the bank shall not guarantee its correctness, trustworthiness, or integrity. The bank shall also not be liable for any damage, whatsoever, arising from this information. 5. This publication is not deemed to constitute advice, solicitation or recommendation to sell financial assets. 6. This document is a translation of the Japanese original, and the original will take precedence in the event of any difference between the two versions. 6