The People’s Bank of China (PBOC) controls the onshore yuan’s (CNY) exchange rate against the US dollar by maintaining a strict trading range around a daily fixed mid-point. Following the New York market close, the PBOC announces the onshore yuan’s fixing rate for the next trading day. It determines the fixing against the US dollar using a weighted average from quotations submitted by market makers. Although the mechanism was last updated in January 2020, the PBOC remains the primary driver of the onshore yuan’s value, with the goal of maintaining currency stability.
Meanwhile, the offshore yuan (CNH) trades more freely and is less tightly controlled than the onshore yuan. While the PBOC does influence the CNH, it is predominantly driven by market forces, such as supply and demand. The increasing opening of China’s financial markets to foreign investors has led to a growing influence of the offshore yuan on the onshore yuan, with the gap between the two rates narrowing. However, the PBOC still remains the ultimate arbiter of the onshore yuan’s value.
China has been steadily pursuing financial liberalization and internationalization of the yuan as part of its long-term strategic plans. A more market-oriented exchange rate regime is a vital part of achieving these goals. However, the PBOC also seeks to ensure stability in the domestic financial system and the broader economy. Speculation and rapid capital outflows can lead to significant yuan volatility, which harms China’s growth and financial stability.
As such, the PBOC’s management of the yuan’s exchange rate is a balancing act between encouraging market forces and maintaining stability. To this end, the PBOC has implemented several tools and policies to stabilize the currency. These include intervening in the foreign exchange markets by selling US dollars and buying yuan; increasing the supply of offshore yuan to ensure that offshore investors have sufficient liquidity; implementing macro-prudential policies to promote capital inflows; and tightening regulations on capital outflows. Additionally, the PBOC directly influences the onshore yuan through the daily fixing.
In recent years, the PBOC has shown increased tolerance for exchange rate flexibility, reflecting both structural reforms in China’s financial system and an evolving view among policymakers. In 2015, the PBOC famously devalued the yuan, triggering a massive sell-off in global financial markets. However, that event also marked the beginning of a more flexible exchange rate regime and increased market influence on the yuan’s value.
Today, the PBOC retains tight control over the onshore yuan’s exchange rate, but allows for a certain degree of flexibility. In recent trade, for example, the PBOC set the yuan at 6.8854 against the US dollar, compared to the last close of 6.8855. This slight adjustment indicates the PBOC’s willingness to accommodate market-inspired exchange rate moves, further signaling China’s gradual allowance for a more market-determined and flexible exchange rate regime.
Looking ahead, China’s ongoing efforts to liberalize its financial markets and internationalize the yuan will likely see the PBOC gradually loosen its grip on the currency. However, it will continue to balance market liberalization with domestic stability. As such, while the onshore yuan’s exchange rate will increasingly reflect market forces, the PBOC will maintain a crucial role in guiding its value to safeguard China’s broader macroeconomic interests.
Overall, the PBOC’s management of the yuan’s exchange rate is a delicate dance between promoting greater market influence and ensuring stability in the domestic financial system. As China’s markets further liberalize and become more integrated with the global financial system, the PBOC will likely continue to adjust its approach to exchange rate management. In the short to medium term, the PBOC is expected to retain control over the onshore yuan’s value, while allowing for increased flexibility in response to market pressures.
