Foreign Exchange Intervention in China

Abstract

This thesis investigates the behaviour of foreign exchange intervention in China and its effects on the RMB’s exchange rate levels and volatility. The research first
examines what drives Chinese central bank’s intervention through buying and
selling foreign exchange (the CB intervention) in a bivariate probit model and shows that intervention is driven by an array of factors including exchange rate deviations, conditional volatility, national economic conditions, interest rate differentials. The PBOC conducts intervention in a leaning-against-the-wind fashion in the medium term, while leaning-with-the-wind intervention is used in the short term.

The thesis next focuses on the intervention in the central parity rate (the CPR
intervention). Evidence from a Bayes Tobit model shows that the CPR intervention
is determined by the market price (proxied by the proposed price by designated
market makers), broad currency index and the yield curve spread. The PBOC adopts a leaning-against-the-wind strategy for the intervention in that when the market price appreciates (depreciates), the PBOC sets a higher (lower) central parity rate to dampen or even reverse the appreciation (depreciation).

To what extent the CB and CPR interventions are effective is then estimated in
threshold GARCH models. Results show that while CPR intervention focuses on
combating appreciation, intervention by the central bank’s purchase or sale
operations (CB intervention) impacts on exchange rate levels when the RMB
depreciates. While interventions would move exchange rate levels to the direction
desired by the authorities, they tend to increase exchange rate volatility.

Finally, event study methodology is deployed to explore the properties and impacts
of China’s oral intervention. The estimation adopts four criteria (event, direction,
reversal and smoothing) to test to what extent oral intervention is effective. Evidence indicates oral intervention through exchange rate communications can influence exchange rate levels and the RMB exchange rate is responsive to international pressure. Furthermore, sequential oral interventions can reduce exchange rate
volatility.