China mulls adjusting yuan-dollar pricing model

Chinese authorities are considering introducing a "counter-cyclical factor" to the existing pricing model of yuan's central parity rate against the U.S. dollar, the China Foreign Exchange Trade System (CFETS) said Friday.

The adjustment, proposed by a working group under the China FX Committee (CFXC), aims to moderate pro-cyclical fluctuations driven by irrational sentiment in the foreign exchange market, the CFETS said.

The yuan-dollar market exchange rates have recorded lower levels from the central parity rate, despite China's improving economic fundamentals and a weakening greenback, the CFETS noted.

The central parity rate of the yuan against the dollar is based on a weighted average of prices offered by market makers, who use models that currently include the closing rate on the inter-bank forex market of the previous day and rate changes against a basket of currencies.

In China's spot market, the yuan is allowed to rise or fall by 2 percent from the central parity rate each trading day.

The CFETS said that China's foreign exchange market is prone to be driven by irrational expectations due to a certain level of "pro-cyclicality," which distorts market demand and supply, and increases the risk of the market exchange rate overshooting.

Adding the "counter-cyclical factor" to the existing model will help correct the trend and steer market attention to the macro-economy, according to the proposal.

The "counter-cyclical factor" would be adjusted in accordance to China's economic performance, it said, so that the central parity rate would better reflect the country's macro-economic operation, the foreign exchange market supply and demand, and exchange rate movements against a basket of currencies.

Details of the model parameters should be determined by market-making banks based on their own judgement on the macro-economy and the foreign exchange market, the proposal said.

A number of market makers, who are also members of the working group, have already made adjustments on specific pricing models for their offers, and the adjustment plan has been discussed and approved at a recent CFXC meeting, the CFETS said.

China has been pushing reform to the yuan's exchange rate formation system to make the currency more market-oriented and helped stabilize expectations.

The central parity rate of the yuan weakened 3 basis points to 6.8698 against the dollar Friday.