China considers 'X' factor in yuan formula to curb volatility

SHANGHAI (Reuters) - China is changing how it calculates the yuan’s guidance rate for the second time this year as it steps up efforts to stabilize the currency and reduce price swings, but some analysts and traders say they are not certain how the process will work.

FILE PHOTO: Chinese 100 yuan banknotes are seen in a counting machine while a clerk counts them at a branch of a commercial bank in Beijing, China, March 30, 2016. REUTERS/Kim Kyung-Hoon/File Photo

The China Foreign Exchange Trade System (CFETS) trading platform, overseen by the central bank, said a "counter-cyclical factor" would be introduced into the way it calculates the yuan's reference rate CNY=PBOC each day allowing it to better reflect supply and demand.

The yuan CNY=CFXS is allowed to trade in a band of two percent above or below the daily midpoint rate.

The People’s Bank of China’s current formula factors in the yuan settlement rate against the U.S. dollar at 4:30 p.m. as well as changes to a trade-weighted basket to determine the next day’s midpoint fixing.

Some market traders speculate that the formula has already been applied with a degree of flexibility, allowing the authorities to move the exchange rate up or down as they see fit depending on external factors.

The revised methodology may make the fixing less predictable and that could affect the ability of participants in offshore yuan markets to speculate on the next day’s fixing.

“This introduces non-market forces into the yuan midpoint mechanism,” said one senior trader at a Chinese bank in Shanghai.

“When there’s huge depreciation expectation for the yuan, the ‘factor’ would allow them to fix the midpoint at a stronger level...It makes it harder to speculate,” he said.

CFETS said in a statement on Friday the change would lessen possible market “herd effects” and help guide the market to focus more on macroeconomic fundamentals. It did not give details about what counter-cyclical factor or factors would be considered, or how they would be applied.

“This new factor could filter out the impact of excessive volatility in the spot market by reducing the closing price’s role in the next day’s fixing,” HSBC said in a note.

The latest move is the second time this year that the PBOC has adjusted its yuan midpoint mechanism.

Unless traders can gain clarity about the new mechanism soon, China risks fresh criticism about a lack of transparency in its foreign exchange policy. The International Monetary Fund and others have urged Beijing to improve transparency after the yuan was added to the IMF’s currency basket last October.

In February, CFETS shortened the reference period of yuan trading against its trade-weighted basket to 15 hours, between 4:30 p.m from the previous trading day to 7:30 a.m, compared with the previous 24 hours, banking sources had told Reuters.

While the yuan has been largely flat against the dollar in recent months, other currencies have been more volatile. The dollar has been whipsawed by uncertainties over how many times the U.S. will raise rates this year and questions over President Donald Trump’s proposed tax reforms and spending plans.

The yuan lost around 6.5 percent of its value against the surging dollar last year. It rose around 0.14 percent on Friday, taking gains so far this year to 1.25 percent to the dollar.

Editing by Jacqueline Wong