5 Things to Know About China's Yuan Policy

Nine months ago, China’s central bank announced a surprise policy shift in how it sets the yuan’s value, pledging to make it more market-based. Interviews with officials and minutes from previously undisclosed meetings show how it has abandoned the policy. Here are five things on what the backpedaling means.

#1: Who sets China's exchange-rate policy?

China’s Communist Party leadership, headed by President Xi Jinping, decides the overall direction of the nation’s currency policy. The People’s Bank of China, which answers to the leadership, manages the yuan on a daily basis and also provides an important role in advising leaders on what to do with the yuan. Because of its lack of independence, the Chinese central bank has to consult with other government agencies on currency issues and often finds itself pulled in different directions by competing interests.

#2: What triggered China's exchange-rate reform last summer?

Based on interviews with officials and meeting minutes, the reform was driven by the leadership’s desire to get the Chinese currency declared an international reserve currency and growing pressure on the central bank to allow market forces to let the yuan weaken. On Aug. 11, the central bank attempted to kill two birds with one stone: It moved to make the yuan more market-driven and paired that with a 2% devaluation.

#3: Is the yuan more market-driven today than before last summer?

The Chinese central bank says it is, pointing to its increased focus on referencing the yuan against a basket of currencies instead of only the dollar. But in practice, the central bank has ditched the market-oriented mechanism it adopted in August and instead has gone back to its old way of controlling the yuan, both by managing the official rate it sets every day and through market intervention.

#4: What has caused the recent backpedaling on exchange-rate reform?

A deepening wariness of market volatility and worry over capital outflows has led the Chinese leadership to prefer currency stability over change. The country’s vast state sector, which holds strong sway with the leadership, also prefers a stable currency due to the mountain of dollar debts state companies have accumulated in recent years. In addition, China’s trading partners have expressed concern over the yuan weakening too fast.

#5: What does the recent weakening of the yuan mean?

In the past three weeks, the yuan has come under pressure again largely because the dollar has resumed its strength. But the PBOC has sought to control the yuan’s descent by both guiding it stronger against the greenback than the market would indicate and by conducting market intervention. Meanwhile, it also has made the yuan a bit stronger against a basket of currencies. All in all, keeping the yuan stable remains the focus of China’s currency strategy.