Yuan Trading Band Doubled

he yuan will be able to trade up to 2% on either side its parity rate.

 Bloomberg News

BEIJING—China sent one of its strongest signals yet that it is pressing ahead on revamping its financial sector, despite a slowing economy, by further loosening its grip on the tightly tethered yuan.

Starting Monday, the yuan will be able to trade as much as 2% on either side of what is known as the parity rate, a daily peg for trading of the yuan against the U.S. dollar that is set by the central bank. Until now, the People’s Bank of China had allowed investors to push the yuan’s value 1% in either direction of parity.

The easing comes as China’s economy is testing a 15-year low in year-over-year growth, leading to questions of whether Beijing would continue its economic and financial overhauls or pull back to help struggling companies. The concern was exacerbated when the central bank engineered a decline in the yuan’s value over the past few weeks. A weaker yuan could help Chinese exporters by lowering the price for their goods internationally.

But according to central bank officials, the PBOC’s attempts were aimed at thwarting short-term speculators betting on the yuan’s continued rise and introducing greater two-way volatility into its trading, as the bank was preparing for expanding the trading band. The influx of speculative capital has complicated China’s efforts to manage the economy, contributing to property bubbles and injecting excess cash into the financial system.

Widening the band now shows that “the central bank is pretty satisfied with the effort to punish speculators,” a PBOC official said.

Some analysts say the PBOC has handled the speculation issue well by steering the exchange rate to roughly its equilibrium level before moving to widen the band. “You don’t want to do this when there is huge pressure [on the yuan] to go up or down,” said Tsinghua University economist Li Daokui, a former adviser to the central bank.

The dollar was trading at 6.1587 yuan in early trading on Monday, amounting to a 1.7% decline in the yuan’s value since the beginning of the year. That is a drastic decline for a currency that gained 2.9% last year and has appreciated more than 30% since the re-evaluation in 2005, when China dropped the yuan’s decadelong peg to the dollar.

Some investors think the yuan, also known as renminbi, has further to fall in the near term, although few view the recent depreciation as anything more than a temporary departure from a longer-term trend of steady appreciation, given China’s still-substantial growth. Some are preparing themselves for more volatility in trading.

Francois Du Pasquier, head of foreign exchange for Citigroup Inc.’s private-banking unit, said some of his clients have started to bet against the yuan through the options market, the first time he has seen this happen. Most of his clients are wealthy individuals in North America, he said.

“The fact that we’re starting to see investors want to express bearish views on the Chinese currency is really a sign that you’re getting a two-way market,” Mr. Du Pasquier said. “This is good news that the renminbi is starting to become a normal currency.”

Some investors say the returns on the Chinese currency may not be as big as they used to be because of the potential for greater volatility. “It may give some investors second thoughts before they pile into [the yuan], as there’s no more free lunch,” said Kevin Daly, a portfolio manager at Aberdeen Asset Management PLC, which manages $321 billion and has bullish bets on the yuan.

Despite the widening of the trading band, China’s central bank has indicated that full flexibility of the yuan remains a long way off. In comments posted on its website Saturday, the PBOC said it will speed up its effort to give the market a bigger role in deciding the yuan’s exchange rate while reducing its “routine intervention” in the currency market. But it will still resort to “necessary adjustments” to keep the exchange rate stable, the bank said, and argued that there is no basis for either a big drop or a big jump in the yuan’s value.

“Many investors will still like the trade,” said Michael Ganske, head of emerging markets at Rogge Global Partners, which manages $58 billion and is betting on the yuan’s appreciation. “It became just less compelling…with more volatility going forward.”

China’s economy weakened sharply during the first two months of the year, prompting many analysts to cut their forecasts for the country’s economic growth this year to below the official target of 7.5%.

A freer currency market is one of the first steps from China’s new leaders to overhaul the country’s financial system, which economists both inside and outside the country have said is inadequate to sustain the world’s second-largest economy. The leadership also pledged to free up interest rates on deposits, allow greater access for foreign capital to come in and for domestic capital to move out, and introduce more competition to what is now a state-dominated model. All of the measures are part of Beijing’s plan to create a consumer-driven economy, rather than one that relies on exports or capital-intensive industries at home.

A freer yuan can also help China deflect foreign complaints about its currency policies. The U.S. and other advanced economies have pressed Beijing for years to relax its hold on the yuan, with the hope of boosting consumer demand in China for foreign goods as consumers elsewhere pull back amid still-fragile economies.

In addition, loosening its hold on the yuan can help the PBOC focus more on domestic monetary policy while reducing the need for currency intervention, PBOC officials say. That is because as the yuan’s floating range gets bigger, it won’t touch the upper or lower limit of the band as frequently as it has, thereby lessening the central bank’s perceived need to meddle in the currency market in a bid to rein in or prop up the yuan’s value.

As a result, the PBOC is expected to issue fewer yuan for the purpose of exchange-rate intervention, and that could leave it with more room to manage domestic monetary policy. “While band-widening itself has little impact on the economy, the possible consequence could be used to stabilize the growth,” because it could leave room for the PBOC to ease its monetary policy, said Zhu Haibin, an economist at J.P. Morgan Chase & Co.

The yuan’s trading band was last widened in April 2012, from 0.5% to 1%, and before that from 0.3% in May 2007.

“We believe the PBOC won’t stop here,” said Lu Ting, an economist at Bank of America Corp. “A much more important and meaningful reform is to change the rule on setting the daily fixing.”

As an intermediate step, he said, that could involve China pegging the yuan to a basket of currencies weighted by the importance of its trading partners.

China has long resisted calls to allow its currency to fully float while preferring a more gradual approach, fearing any drastic measures would destabilize its primitive capital markets or hurt its powerful export sector.

Some Chinese exporters are taking the yuan action in stride. “It’s a good thing for us that renminbi still trades within a range, which means its volatility is limited compared to other currencies,” said Li Zhongjian, who runs a business in Wenzhou, a city in eastern China, that makes and sells lighters to the U.S., Europe and southeast Asia.

“A stable renminbi makes it easier for us to estimate costs and price our products.”

–Bob Davis and Richard Silk contributed to this article.