China’s new renminbi tactics leave traders guessing

China is changing its tactics on the renminbi, according to analysts and traders, with a shift away from direct intervention and towards lower-profile, indirect tools to steer the market.

The currency dropped almost 8 per cent last year against the soaring dollar. But Beijing smoothed out that decline using tools such as so-called “invisible reserves” held by state banks, rather than its more typical heavy-handed intervention by the People’s Bank of China.

Beijing’s new approach to currency management poses a challenge to traders seeking to anticipate the renminbi’s next move, and to foreign officials, such as the US Treasury, who want to understand how tightly China’s currency is controlled.

“China’s overall foreign exchange management framework has changed,” said Becky Liu, head of China macro strategy at Standard Chartered. “When you directly intervene, people calculate how much [reserves] you have to burn on a monthly basis and how many more months you have left. In that situation people will short the renminbi at all costs,” Liu said. “This time around, they’re putting a lot of other measures in place so the amount of foreign exchange interventions needed is lower.”

China operates a managed float of its currency. Every day, the PBoC fixes a trading range against the dollar, but over the medium term the renminbi can fluctuate in line with market pressures, which this year have been dominated by a climb in the US currency. China also uses capital controls to restrict the movement of money in and out of the country.

Sometimes, however, a strong desire for capital inflows or outflows puts strain on the system. The key example of that was in 2015, when China’s central bank engineered a one-off depreciation of the renminbi as part of a reform programme. Outflows quickly accelerated, leaving the central bank ripping through hundreds of billions of dollars to support its currency in a battle that became a focus for global markets.

Last year, global currency markets were dominated by a march higher in the dollar; the US currency was up by nearly 20 per cent at its peak in September, pushed up by rapid rises in interest rates. It closed out the year up 8 per cent against a basket of half a dozen peers.

In the autumn, the combination of China’s zero-Covid policy and the reappointment of Xi Jinping for a third term as president focused the pressure on the renminbi, helping to push it to its lowest level against the dollar since 2007.

Authorities have developed a range of subtle tactics to respond, said traders. For example, they may fix the daily trading band higher than the market expects — a signal that it is willing to see the renminbi fall — or it may give so-called window guidance to encourage or discourage renminbi-dollar trading by state banks.

In addition, market participants said state-run banks had bought renminbi on the central bank’s behalf, preserving China’s foreign exchange reserves.

“There’s no denying authorities have mobilised invisible foreign reserves from state commercial banks to manage the market,” said a trader at one of China’s largest state-run securities firms. “You can’t really touch the state reserves, which are closely watched — that would trigger waves of panic and be counterproductive for regulators’ efforts to guide market expectations.”

Yet currency traders in China who experienced the 2015 rout said state lenders’ renminbi purchases in 2022 had been less frenzied.

“The buying momentum from state banks . . . was actually not as great as back in 2015,” another Shanghai-based foreign exchange trader said. “After all, all the non-dollar currencies have depreciated significantly, so the renminbi’s performance didn’t look too bad.”

Zhi Xiaojia, head of Asia research at Crédit Agricole, said Beijing’s moves to influence the exchange rate “were not meant to stop or even reverse [depreciation] or target any level as a hard line of defence, as it would be too costly — especially against the backdrop of continued dollar strength”.

That is in keeping with growing official tolerance from senior Chinese officials for volatility in the exchange rate. In November, Pan Gongsheng, director of China’s Safe foreign exchange regulator, told attendees of a forum in Beijing that “an emerging feature of China’s forex market is [the renminbi’s] more robust flexibility”.

Former officials have been more direct. In a chapter of his book published in September, Guan Tao, a former Safe official and chief economist at Bank of China International, advised the PBoC to make the renminbi exchange rate more flexible “to release market pressure and avoid expectations of one-way appreciation or depreciation”.

To that end, StanChart’s Liu said the central bank could decide to widen the renminbi’s dollar trading band, which is the narrowest of the 24 currencies allowed to trade directly against the Chinese currency.

“The band is not only an asset in helping to maintain stability but also a liability because when you have the band, it’s mandatory to conduct direct spot interventions when either side of the band is hit,” she said. “Now may be a good time for the PBoC to consider widening the band from 2 to 3 per cent.”