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It has been a year since the People's Bank of China carried out its exchange rate reform, extensively marketizing the exchange rate of the yuan against the dollar. The PBOC now maintains the stability of the yuan against a basket of currencies set by International Monetary Fund, fixing the yuan's daily trading midpoint according to the currencies' closing rates on the previous day.
On August 11, 2015, China's central bank announced it would fix the yuan's daily trading midpoint by basing it on the closing price at the end of the previous trading day. The decision caused weeks of international consternation, because it resulted in a depreciation of the yuan. However, it also had the effect of internationalizing the Chinese currency. This was furthered in December when the exchange rate system started tracking the value of the yuan against a basket of currencies apart from the U.S. dollar.
"Before the reform, the RMB was overvalued if you look at the economic fundamentals. So what was needed was an appropriate way to devalue in an orderly manner. Last July, the International Monetary Fund approved the Renminbi joining its Special Drawing Right, but they said they believed the exchange rates and the midpoint fixing were not marketized enough," said Wan Zhao, senior analyst of China Merchants Bank.
And sure enough, last November, just three months after the PBOC's exchange rate reform, the International Monetary Fund announced that it would accept the yuan into its Special Drawing Rights basket, a major milestone in establishing the yuan's position as a global currency. In addition to that success, one director at Societe Generale believes the reform has also helped banks and companies to better understand how exchange rates can be used to hedge their currency risks.
"From the market's point of view, traders, clients, companies and banking peers now have a better understanding and knowledge about the trends of the yuan's fluctuation. In terms of risk control and market judgement, financial institutions and companies are more confident with the yuan as an international currency as well as a currency hedging tool," Gu said.
The Chinese yuan will officially join the SDR basket on October 1, with a weighting of 10.92 percent, higher than the Japanese yen and the British pound. Gu says the central bank's next step in internationalizing the yuan makes it easier for foreign investors to enter the Chinese market.
The PBOC also announced earlier this year it would be cancelling the quota limitation system for foreign institutional investors in China's interbank bond market, though the quotas have not been dropped as of now.
