RMB daily trading band may widen to 3%

Economists predict China will soon expand the daily trading band of renminbi (RMB), or the yuan, to 3 percent after a recent promise for a more flexible exchange rate.

The State Council, or China's Cabinet, announced on July 24 that it will broaden the RMB daily trading range but did not disclose more details or the timeline.

Currently Chinese banks can exchange yuan at the foreign exchange (FX) spot market at 2 percent above or below the central parity rate against the U.S. dollar announced by the China Foreign Exchange Trading System each trading day.

Liang Hong, a macro analyst with CICC, wrote in a research note the plan is likely to be implemented within the next 2 months by widening the band to 3 percent around the fixing rate.

If confirmed by the central bank, the move will mark an important step to let the market play a larger role in determining the yuan's relative prices, Liang said.

Giving out a similar forecast, a report of Huatai Securities noted the action showed China has began hastening its financial reform in response to the vulnerability of a financial system exposed by the volatile equity market.

China takes a gradual and steady pace in raising its currency's daily trading limit, from 0.3 percent in 1994 to 0.5 percent in 2007 and 1 percent in 2012 to the latest 2 percent in 2014.

Both institutions believe a widened trading band will be a boon to the yuan's inclusion into the currency basket of the Special Drawing Rights (SDR) of the International Monetary Fund (IMF).

Liang said the move will reduce the technical barriers, while Huatai Securities thought it is another step towards the liberalization of the currency and showed a positive signal that China will continue to push forward reforms.

The IMF is conducting its five-year review of the SDR basket this year and will decide whether to include the yuan into its basket this fall.

The yuan appreciated by more than 30 percent after the central bank loosened its grip on the exchange rate in 2005, and analysts believe the value of the yuan has reached equilibrium.

The central parity rate of the yuan stood at 6.1176 against the U.S. dollar on Monday.

Liang said policymakers are still cautious when reforming FX.

"China's financial markets, especially its FX market, remain underdeveloped and do not seem well-prepared for even greater exchange rate fluctuations," Liang said, "the People's Bank of China (PBOC) may not let the dollar peg go any time soon."

However, "an increasingly market-based exchange rate regime implies that the PBOC will gradually withdraw from FX interventions." Liang added.

Analysts expect the RMB's exchange rate may stay on the weak side in the short term after the band widening but will not fall into a losing streak in the long run.