China has been pushing through reforms to internationalize its currency.
As China’s economy grows and it exercises greater political influence, the renminbi is also set to take on a greater role in global markets.
The European Central Bank’s executive board member Yves Mersch said the renminbi could one day challenge the U.S. dollar as the world’s leading reserve currency.
But China’s efforts to slowly liberalize its currency have led to the creation of the offshore yuan. And the rules that govern the currency can also be tricky. As China begins to step up reforms, it’s important to understand the basics of the Chinese currency.
With that in mind — and the fact that the Chinese currency has been weakening — we’ve answered some of the most frequently asked questions about the renminbi.
What is the difference between the renminbi and yuan?
The renminbi is the currency of the People’s Republic of China and is designated by the symbol RMB. The yuan is a unit of the renminbi with the currency code CNY. The yuan has further denominations. 10 jiao make up one yuan and ten fen make up one jiao.
How is the price set?
The renminbi is not a free floating currency like the U.S. dollar. The renminbi was pegged at 2.46 yuan for one U.S. dollar since the currency was introduced in 1948. In the 1980s, it strengthened to a high of 1.50 yuan and was devalued to 8.62 yuan by 1994. China finally revalued its currency in 2005 to 8.11 yuan per U.S. dollar and let it trade within a narrow trading band starting 2006.
Since then the currency has appreciated some 30% against the greenback. But even so China has controlled how much the currency fluctuates on a daily basis. China recently widened its yuan trading band to 2%, from 1%. China last widened the band to 1%, from 0.5% in April 2012, and to 0.5% from 0.3% in May 2007.
While this has been an important step towards internationalizing the renminbi and establishing market-based exchange rate, analysts a more meaningful reform would be for the People’s Bank of China to relinquish control of the exchange rate.
The central bank has a daily fix against the dollar and can thereby guide the currency higher or lower. The China Foreign Exchange Trade System (CFETS) publishes the daily fix each day and the renminbi can now trade withing a 2% band in either direction i.e. it can rise or fall. But as long as China has daily fixes it can continue to guide the currency lower or higher and smooth out appreciation or depreciation as it sees fit.
What is the difference between the offshore and onshore yuan?
As China began to open up its economy, it wanted the renminbi to be used in the international market to settle trade and financial transactions. But it wanted to do so without fully opening up its capital account and risking capital outflows.
Hong Kong, which has served as an international hub for mainland China, served as a great place to start an offshore renminbi market.
The crucial thing to understand about the offshore market is that the yuan floats freely and doesn’t fluctuate within a tight band like in the onshore market, and is free of Beijing’s control in that regard. This allows for different prices on a single currency and creates those arbitrage opportunities that the PBoC is now trying to squelch.
Those participating in the offshore Forex market can only participate in the onshore market through Qualified Foreign Institutional Investors (QFIIs) which are granted quotas to participate in onshore trading and investment. But corporates can also participate through a cross-border settlement process.
The CNY is the currency code for onshore yuan (in mainland China), meanwhile CNH is the code for offshore yuan traded in Hong Kong and other offshore markets.
Who regulates the onshore and offshore renminbi market?
The CNY market is regulated by the PBoC and the State Administration of Foreign Exchange (SAFE). SAFE is responsible for regulating Forex market activities and transactions in both the current and capital account. It also works with the central bank on structuring exchange rate policy.
The Bank of China (BOC) is the central clearing bank for the RMB Settlement System. The CNH market is regulated by the Hong Kong Monetary Authority which can not intervene in the market.
Can the renminbi threaten the U.S. dollar’s dominance?
The role of the renminbi in international trade settlement has grown and central banks around the world have increased renminbi holdings in their reserves. SWIFT said this year that the yuan knocked out the Swiss franc to become the seventh most used currency. The ECB’s executive board member Yves Mersch has said the renminbi could one day challenge the U.S. dollar as the world’s leading reserve currency.
The answer to this is unclear. A lot of this will have to do with how successful China is in internationalizing its currency and reforming its economy. If it does so successfully, it will have major implications for global markets and financial stability.
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