China's tweaks to CFETS index basket could drive yuan higher - analysts

SHANGHAI, Jan 4 (Reuters) - China’s decision to cut the weighting of the U.S. dollar in a key currency index basket could push the yuan’s value higher against its peers this year, some analysts said.

The China Foreign Exchange Trade System (CFETS), which is managed by the People’s Bank of China (PBOC), said late last week that it would adjust weightings in its currency basket starting Jan. 1.

Analysts noted the move, which reduces the impact of dollar moves and boosts the weighting of currencies including the euro , comes as China seeks to reduce its dependence on the U.S. currency for trade and finance.

The changes could also affect the setting of the midpoint for the yuan’s daily trading band. The daily fixing is based on the yuan’s moves in the previous session and changes in currencies in the yuan baskets.

“After lowering the dollar weighting, the impact from fluctuations in the dollar index on the yuan’s midpoint fixing would be elevated,” Zhang Yu, chief analyst at Huachuang Securities, said, adding that more yuan volatility is likely.

The onshore yuan is limited to a 2% range around the midpoint each day.

“Broad dollar weakness will tend to result in more appreciation in the yuan and vice versa if the PBOC maintains the CFETS RMB index steady,” said Gao Qi, FX strategist at Scotiabank.

Guo Jiayi, chief currency analyst at CIB research, said the adjustment could boost the yuan’s real effective exchange rate in the long-run.

She said changes to currency weightings should not influence the yuan’s overall trend, but lowering the greenback’s weight could be a sign of continued “de-dollarisation”.

Some market participants noted that the heavier euro weighting followed an investment deal between China and the European Union that will give European companies greater access to Chinese markets.

“The increase of euro weight in RMB index from 2021 suggested that RMB index may be stronger slightly under the new weight than the old weight,” said Tommy Xie, head of Greater China research at OCBC Bank.

The CFETS index finished last year at 94.84, up 3.8% on year, while the yuan strengthened 6.7% against the dollar.

The basket adjustment was largely in line with trade volume, traders said, ensuring China isn’t disadvantaged on exchange rates versus its trading partners.

China has adjusted the CFETS basket three times since it introduced the trade-weighted yuan exchange-rate index in December 2015 to better reflect external trade conditions.

China lowered the dollar’s weighting in the basket last year after boosting the number of currencies to 24 from 13.