August 2003
Statement on Monetary Policy
Box C: The Chinese Renminbi
Since the devaluation in 1994, China has
maintained its exchange rate within a
0.3 per cent band either side of its target
rate 1 (Graph C1). In the context of
continuing trade surpluses, strong capital
inflows and sharply rising official reserves
(Graph C2), there have been calls from time
to time from various commentators for
China to free up its exchange rate, with the
implication that it should appreciate.
Graph C1
Renminbi Exchange Rate
Yuan per US$
Chinese Foreign Exchange Reserves
US$b
US$b
300
300
200
200
100
100
0
CNY
CNY
8
0
1993
1995
1997
1999
2001
2003
Source: CEIC
8
6
6
4
4
2
2
0
Graph C2
l
l
l
l
1987
l
l
l
l
1991
l
l
l
l
1995
l
l
l
l
1999
l
l
l
0
2003
Sources: RBA; Reuters
Financial markets pricing suggests that
market participants see the possibility of a
revaluation of renminbi as having increased.
This is evident in both implied volatilities
from the currency options market and in
non-deliverable forward (NDF) rates. The
implied volatility from a currency option is
a measure of the variability that the market
sees in future movements in the exchange
rate over the life of the option contract. In
the context of a fixed exchange rate, implied
volatility largely reflects the expectations of
an upward or downward adjustment to the
peg. Over the past year, on two occasions
when US officials have talked about the
possibility of China adopting a more flexible
exchange rate, there has been a significant
reaction in the options market. In June 2003,
for example, implied volatilities on options
to buy or sell renminbi rose sharply from
around 2.5 per cent to 4 per cent for 1-year
contracts, and from 0.5 per cent to
1.3 per cent for 3-month contracts
(Graph C3). Also implied volatilities were
larger for ‘out of the money’ options to buy
renminbi, than for equally ‘out of the money’
options to sell the currency, thereby
suggesting that the balance of expectations
was skewed towards an appreciation of the
Chinese currency against the US dollar.
Another gauge of the anticipated direction
of a change in the value of renminbi is the
NDF rates relative to the spot exchange rate.
NDFs are forward contracts in which, at the
expiry of the contract, the difference between
the prevailing spot exchange rate and the
contract rate is settled in cash.
1. China's currency is generally known as renminbi, or ‘People’s currency’, but the unit of measurement is the
yuan (the terms are parallels of ‘sterling’ and ‘pound’ in the UK).
22
Reserve Bank of Australia
August 2003
Graph C3
Renminbi Implied Volatilities
%
%
4
4
1-year
option
3
3
2
2
3-month
option
1
0
l
l
F
l
l
A
l
l
l
J
A
2002
l
l
l
O
l
l
D
l
l
F
l
exchange rate. The discrepancy between
NDF rates and the spot exchange rate was
particularly pronounced in June 2003, when
NDF rates temporarily fell 2 per cent below
the spot exchange rate for one year contracts,
and 0.4 per cent below the spot exchange
rate for 3-month contracts (Graph C4).This
suggests that investors had attached a higher
probability to an upward revaluation of
renminbi, with expectations being more
pronounced at longer horizons. R
1
l
l
A
J
2003
l
l
Graph C4
0
Renminbi NDF Rates
A
CNY
CNY
Source: Bloomberg
8.75
Given that China has higher interest rates
than the US, in the absence of expectations
of a change in the target exchange rate one
would expect the forward exchange rate
(expressed as yuan per US dollar) to be
higher than the spot exchange rate so as to
eliminate the possibility of earning a
risk-free profit over the term of the contract.
However, since November 2002, NDF rates
have typically been below the prevailing spot
8.75
Yuan per US$
1-year NDF rate
8.60
8.60
8.45
8.45
8.30
8.30
Yuan per US$
spot rate
8.15
Yuan per US$
3-month NDF rate
l
8.00
2000
l
2001
8.15
l
2002
8.00
2003
Source: Bloomberg
23