China should reform FX system to promote yuan flexibility

China should urgently reform its foreign exchange rate system or risk impeding the economy and plans for the yuan to play a larger role on the global stage, a central bank adviser said on Wednesday. Huang Yiping, a member of the central bank's monetary policy committee, told a forum in Beijing that an inflexible foreign exchange rate would limit the opening of the economy and yuan internationalisation.
Efforts to promote the yuan on the international stage have actually "gone backwards", in some respects, as a result of inflexibility and efforts to stop capital outflows, he said. Reforms to the exchange rate system were "a relatively urgent matter", he said without elaborating. Officials at the People's Bank of China reiterated through different channels over the past few months that the country would continue to promote yuan internationalisation, which was a long-term strategy.
The yuan is limited to trading within a band of two percent on either side of a midpoint reference rate determined daily by the central bank. Late last month, the PBOC said it was considering changes to the way it set the midpoint, adding a "counter-cyclical factor" to the formula. It has yet to explain this new element in detail, but analysts and traders think it gives the PBOC more leeway to alter the rate irrespective of market conditions.
Analysts say curbs on capital outflows imposed last year have checked the pace of the internationalisation of China's currency. In 2016, the yuan weakened 6.5 percent against the resurgent dollar. So far this year, the yuan has strengthened around 2.3 percent against the dollar. Last week was the yuan's best week since February 2016, as it gained 0.65 percent against the dollar - a sizable leap for a currency that normally trades in a wafer-thin range. The yuan's sudden reversal has diminished expectations the currency is on a weakening path, and the moves via state banks to prop up the excahnge rate appeared to have gathered pace from May 24, when Moody's Investors Service downgraded China's sovereign credit rating for the first time since 1989.