China is changing its RMB exchange rate policy. Here are the key quotes:
In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.
In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.
I can think of a few reasons why they are choosing to do this now.1. By promising action right before the G20, it allows them to avoid this contentious issue and instead make the developed countries focus on their debt problems. 2. They have been trying to moderately tighten their policy in other ways, so this move is a natural extension of their policy that as an added benefit placates members of the international community.3. They figured that because everyone is now worried about the Euro, they could change to a basket and have a smaller effect on the markets than if they implemented this policy while everyone was already selling the dollar. 4. Due to recent currency movements, they are worried about export competition from manufacturing in the Euro-zone more than they are about US competition. This move could be a medium term move to strengthen the Euro. Of the above reasons, #1 and #2 are pretty obvious and are generally well known. #3 seems like it could be true, while for #4 to be correct the reference basket of currencies would have to be changed pretty drastically. It is worth noting that while the language does not imply revaluation, but as long as the forward rates are pricing in some type of revaluation (and the only time they don't seems to be when there is a liquidity shock and people are forced to exit their positions) the last time the PBOC used similar language the RMB appreciated pretty steadily for a few years. However, this steady appreciation encouraged speculation in RMB based assets, driving up the real estate bubble that China is presumably worried about now. If they let (encourage) the RMB be priced to steadily appreciate at a similar rate again that would imply that either they haven't learned their lesson or that the party has decided that they cannot let the real estate bubble collapse anytime soon and are desperate to keep it going.