China seeks to sustain yuan stability against basket of currencies

While the RMB has depreciated against the dollar by roughly 4 percent since the beginning of this year, it has actually appreciated by 0.87 percent against a basket of currencies as of Dec. 25, compared with the end of 2014, according to the CFETS RMB Index.

"I think it helps to avoid some of the concerns that occurred this year when people were worried the RMB depreciated quite rapidly against the U.S. dollar, they lost the anchor for expectations about the exchange rates," said Collyns, a former assistant secretary for international finance at U.S. Treasury. "I think the PBOC now establishes a new anchor, which will be helpful to stabilize the expectations."

"China's exchange rate will no longer be dragged upwards against all other currencies by a rising dollar. But it is still likely to broadly stable against the world as a whole," Gavyn Davies, former chief economist of Goldman Sachs and now chairman of Fulcrum Asset Management, echoed Collyns's views.

"Basically we see a broadly stable effective rate fluctuating around a rate of about 102.5 (using the authorities' suggested base of 30 December 2014=100). The margins around this rate seem to be about 2.5 percent either way," Davies wrote in an analysis on his Financial Times blog, referring to the CFETS RMB Index.

Tamim Bayoumi, senior fellow at the Peterson Institute for International Economics, a Washing D.C.-based think tank, encouraged China to take bold steps to formally announce a new exchange rate regime linking to a new basket, which would be in the interests of both China and the international monetary system.

"Making the bold move of linking to the new basket published by the CFETS with a wider intervention band provides the potential for a smooth switch from the current system to one where one-way bets are less obvious, incentives to overborrow in dollars are curtailed, and renminbi markets are encouraged," Bayoumi wrote in a recent article published on the institute's website.

While moving towards a basket of currencies was probably the best thing for China, there was "a very significant psychological problem", said Pieter P. Bottelier, a senior adjunct professor of China studies at the School of Advanced International Studies of the Johns Hopkins University.

"We have to assume that in the minds of people running capital markets, the RMB-dollar exchange rate will remain very important," Bottelier told Xinhua in a separate interview, noting that the RMB's bilateral exchange rate against the dollar will continue to be one of the most closely watched indicators.

Bottelier said "there is an additional reason to be careful with the dollar exchange rate", given the fact the RMB was approved by the International Monetary Fund (IMF) to join its Special Drawing Rights (SDR) basket as a fifth reserve currency, along with the dollar, euro, pound sterling and yen, on Nov 30, 2015.

"That's what everybody will be looking at, including US Congress," said Bottelier, who served as chief of the World Bank mission in Beijing during the 1990s. "For the next year or two, you have to be very careful with the RMB-dollar exchange rate. It's probably better trying to preserve relative stability."

Bottelier believed the Fed's rate hike was potentially "a good thing" for China as it would help push forward China's financial reforms.

"With the Fed beginning to raise the interest rates and Chinese central bank trying to lower them, it's possible that at some point in the next year or two the domestic interest rates in China and international rates will be above the same level," Bottelier said. "Once you have that, it becomes possible for China to completely open the capital account and go to completely convertible capital system."

The PBOC approved RMB convertibility on the capital account within a prescribed limit of 10 million dollars for the Tianjin, Guangdong and Fujian free trade zones on Dec 11, a historic step by China to open up its capital accounts.

Bottelier said China should be cautious and not in a hurry to complete open the capital account because of the risks of huge capital inflows or outflows, which are potentially disruptive. In his view, "it's probably in China's interests to retain at least some controls" on the capital account in the end.

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