SMM News: at a time when China's foreign exchange market is surging again, Pan Gongsheng, deputy governor of the people's Bank of China and director of the State Administration of Foreign Affairs, made an interesting interview yesterday, and a series of recent actions by the central bank have also attracted a great deal of attention from all sides.
On May 14, the offshore RMB exchange rate against the US dollar fell below 6.9, approaching 7 levels-although the RMB exchange rate has fluctuated sharply in the stormy market several times since the "August 11 exchange rate reform" in 2015. However, it always adheres to the integer level of "7".
At a time when China and the United States are in the stage of trade negotiations, if the renminbi falls sharply, it is likely to further heat up the situation. China's central bank governor said in March that China would not boost exports through competitive currency devaluations.
So how do we understand Pan Gongsheng's soothing sentence over the weekend, "We have the foundation, confidence and ability to maintain the stable operation of China's foreign exchange market and the basic stability of the RMB exchange rate at a reasonable and balanced level?" Or how can the central bank keep the currency market stable this time?
Typically, central banks can use their foreign exchange reserves to intervene directly into the market, such as selling dollars and buying renminbi in the offshore market to ease the pressure of devaluation by changing supply and demand. The central bank's foreign exchange share fell slightly for four consecutive months, indicating that the central bank may not have directly intervened in the foreign exchange market.
"the central bank basically adjusts and controls the exchange rate in the offshore RMB market in Hong Kong," Pan Xiangdong, chief economist of New era Securities, and Liu Juanxiu, an analyst, issued a research report on the day of Pan Gongsheng's interview, pointing out the "secret" of the central bank's recent stability of the foreign exchange market.
According to their analysis, the central bank issued a central vote in Hong Kong the day after the offshore exchange rate approached 7 in an attempt to "stabilize market expectations and support a stable recovery in the offshore renminbi exchange rate".
Wall Street had previously mentioned that on May 15, the central bank issued more than 100 billion yuan of central bank tickets for the third time in the history of Hong Kong.
How on earth does the central bank affect the onshore RMB exchange rate by regulating the offshore RMB exchange rate? Pan Xiangdong and Liu Juanxiu explained that issuing offshore central bank notes can tighten the liquidity of offshore renminbi, thereby raising the cost of shorting the renminbi, thereby stabilizing the exchange rate:
The central bank can tighten the liquidity of the offshore renminbi by issuing offshore central bank notes in Hong Kong, thereby tightening the liquidity of the offshore renminbi, which can raise the cost of shorting the renminbi to some extent, thereby stabilizing the exchange rate in the offshore renminbi market.
Because the time limit of the central bank is relatively flexible, and the issuing procedure is relatively simple, it is convenient for the central bank to regulate and control the exchange rate more flexibly.
This time, the central bank chose to issue offshore central bank notes in Hong Kong again at a time when the RMB exchange rate against the US dollar has been continuously lowered, tightening offshore liquidity, which can play a role in stabilizing market expectations, thereby supporting the rebound of the RMB exchange rate. The issuance of offshore central bank notes broadens the channels for the central bank to regulate liquidity and also helps to promote the internationalization of the RMB.
Why do central banks have to choose the offshore renminbi market over the onshore market? Pan Xiangdong's team explained that this is because the offshore renminbi deposits and trading volume in Hong Kong is larger than that in other offshore RMB markets, so the central bank basically adjusts the exchange rate in the offshore RMB market in Hong Kong.
The key to influencing the onshore exchange rate with the offshore RMB market is that the offshore and onshore RMB exchange rates have a strong linkage effect.
The linkage effect of offshore and onshore RMB exchange rate is the basis for the central bank to intervene in the onshore exchange rate through the offshore market. Because of being uncontrolled, the offshore RMB exchange rate is more sensitive to the changes of economic fundamentals, which is greatly affected by the change of risk preference in the international market, coupled with the difference in liquidity between the two, resulting in the difference between offshore and onshore RMB exchange rates. However, there is a linkage effect between offshore and onshore RMB exchange rates, so the price difference between the two will not be too large, most of the time within the 100BP. However, since the beginning of May, the spread between offshore and onshore RMB exchange rates has widened significantly, and as of May 17, the offshore RMB exchange rate closed at 6.9486, which is higher than the onshore RMB exchange rate by 347BP.
The offshore and onshore RMB exchange rates mainly influence each other through the following channels:
First of all, it is influenced by the trade settlement channels of cross-border trade enterprises. For the sake of their own interests, cross-border trade enterprises choose the most favorable market to trade in the offshore and onshore markets, thus affecting the relationship between RMB supply and demand, and then converging the onshore and offshore RMB exchange rates. When the expected devaluation of the renminbi increases, the offshore dollar against the renminbi is generally higher than the onshore dollar against the renminbi, and the dollar can be exchanged for more renminbi in the offshore market than in the onshore market. When the same dollar can be exchanged for more renminbi in the offshore market, companies are more willing to trade in the offshore market, resulting in more renminbi income, which will lead to the appreciation of the offshore renminbi. At the same time, importers tend to trade in the onshore market, so the same dollar pays less renminbi than the offshore market, which will lead to the devaluation of the onshore renminbi. In the end, the spread between onshore and offshore RMB exchange rates narrowed.
Secondly, it is influenced by the arbitrage channel of offshore and onshore RMB forward market. Trading in the non-deliverable forward foreign exchange market (NDF) is a non-deliverable forward contract. The parties to the transaction determine the forward exchange rate, duration and amount at the time of signing, and directly settle the difference between the forward rate and the actual exchange rate at the expiration of the contract. There is no need to deliver the principal, so it does not involve the direct exchange of local currency and foreign currency. Forward settlement and sale of foreign exchange (DF) refers to the transaction parties to sign a forward settlement and sale of foreign exchange agreement, agreed on the future settlement and sale of foreign exchange currency, amount, time limit and exchange rate, after maturity for cash foreign exchange delivery. Because the quotations in the NDF and DF markets are different and there is risk-free arbitrage space, onshore financial institutions can arbitrage through the onshore RMB forward market and the NDF market. Offshore financial institutions can arbitrage through the offshore renminbi forward market and the NDF market. With the continuous progress of the arbitrage trade, the arbitrage space continues to shrink, and the onshore and offshore RMB exchange rates gradually converge.
Finally, through the market confidence channel influence. In contrast, the offshore RMB market is more closely related to the international financial market, so the change of global risk preference has a greater impact on the offshore RMB exchange rate. In the case of the impact on the international financial market, or the deterioration of the outlook for economic fundamentals, investors' risk appetite will change, thus affecting the flow of international capital, resulting in offshore RMB exchange rate fluctuations. When the offshore RMB exchange rate depreciates due to the lack of market confidence, it will lead to the decline of onshore RMB market confidence, which will lead to the fluctuation of the onshore RMB exchange rate.
Pan Gongsheng also said yesterday: "in recent years, we have accumulated a wealth of experience and sufficient policy tools in dealing with fluctuations in the foreign exchange market, and will take the necessary counter-cyclical adjustment measures to strengthen macro-prudential management in the light of changes in the situation. We will crack down on violations of laws and regulations in the foreign exchange market and maintain a sound order in the foreign exchange market. "