Oct 28, 2020 08:49 PM

Exclusive: China May Scrap Key Ingredient in Setting Yuan’s Daily Fixing

Some lenders in China have already started to omit the counter-cyclical factor from their daily calculations for yuan quotes submitted to the central bank.
Some lenders in China have already started to omit the counter-cyclical factor from their daily calculations for yuan quotes submitted to the central bank.

China may be getting ready to scrap a key element of the way it sets the daily reference rate for the yuan, known as the counter-cyclical factor, sources with knowledge of the matter told Caixin after several banks stopped using the mechanism introduced three years ago.

Some of the 14 lenders who submit quotes for the U.S. dollar-yuan exchange rate to the China Foreign Exchange Trade System (CFETS), part of the People’s Bank of China (PBOC), every morning before it publishes its fixing have already stopped using the factor in their calculations, the CFETS said in a brief statement (link in Chinese) Tuesday, without saying whether the change was permanent.

The banks “took the initiative to phase out the ‘counter-cyclical factor’ based on their own assessments of economic fundamentals and market conditions,” the statement said. “The adjusted quotation model is conducive to improving the transparency, benchmarking and effectiveness of the mid-price provided by banks, and it is also a reflection of the role of market entities in the self-discipline mechanism of the foreign exchange market.”

The sources told Caixin that authorities are planning to do away with the factor, which was introduced in May 2017 after the yuan had been under depreciation pressure for over a year. The details of how the factor is calculated has not been made public, but its aim was to slow any further slide in the currency.

It’s unclear whether the move will be permanent. But even a temporary suspension indicates that the authorities are prepared to give up some control over the yuan-dollar exchange rate and give the market a much bigger role in deciding the value of the Chinese currency. Without having to factor in the counter-cyclical requirement, banks will have more room to submit quotes for a weaker fixing and guide the currency lower in the spot market.

“After the countercyclical factor is removed, the exchange rate formation mechanism will be neutral, its flexibility will be further enhanced,” said Guan Tao, the chief economist of BOC International (China) Co. Ltd.

China has pledged for several years to allow the market a bigger role in deciding the value of the yuan and to open up its financial markets further, including liberalizing interest rates. As top leaders gathered in Beijing this week to map out policies for the economy over the next five years, changing the way the exchange rate is managed and making it more market-oriented may be under consideration.

The CFETS sets the yuan’s daily reference rate, or fixing, at 9:15 a.m. every trading session based on submissions from 14 banks. The currency is allowed to move a maximum of 2% in either direction against the dollar.

Under the current mechanism, the model that banks use to calculate the daily reference rate quotes they submit to the CFETS is based on three factors: the closing price of the previous trading day, the change in the yuan’s value against a basket of currencies and the counter-cyclical factor. But the factor was only used in periods of yuan depreciation and was left idle in stretches of appreciation.

The mechanism has stabilized the exchange rate to some extent and reined in depreciation expectations, according to a Friday report (link in Chinese) by the China Wealth Management 50 Forum, a think tank. But that stability has come at the cost of transparency and is not conducive in allowing banks to develop their own capability in deciding quotes independently, it said. In addition, the mechanism may not be as effective in managing appreciation expectations as it was in managing depreciation expectations, it added.

The yuan has appreciated sharply since May, gaining more than 6% against the dollar and is currently at close to its strongest level in more than two years. The yuan strengthened 0.03% to 6.7138 per dollar in the onshore market on Wednesday.

The yuan is being buoyed by several factors –– positive investor sentiment stemming from China’s economic rebound from the Covid-19 induced slump in the first quarter, weakness in the dollar, and higher interest rates in China compared with other major markets such as the U.S.

Some analysts have said the omission of the counter-cyclical factor in banks’ daily calculations may be an attempt by the central bank to arrest the yuan’s gains and signal it is prepared to see some weakness in the currency. The CFETS has set the daily reference rate weaker for five consecutive trading days and fixed it at 6.7195 per dollar on Wednesday, 206 pips lower than Tuesday.

“It’s definitely better to make any market-oriented reform of the exchange rate in an environment of appreciation,” said Zhang Yu, chief macro economist of Huachuang Securities Co. Ltd. said. “It’s not easy to implement (change) in a depreciation cycle because it may boost expectations for further depreciation.”

Additional reporting by Bloomberg

Contact reporter Guo Yingzhe ( and editor Nerys Avery (

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