2nd LD: China improves exchange rate formation system; yuan falls sharply

China's currency fell sharply in value on Tuesday following the central bank's decision to improve its "central parity system" to better reflect market development in the exchange rate between the Chinese yuan against the U.S. dollar.

Effective beginning Tuesday, daily central parity quotes reported to the China Foreign Exchange Trade System before the market opens should be based on the closing rate of the inter-bank foreign exchange rate market on the previous day, supply and demand in the market, and price movement of major currencies, the People's Bank of China (PBOC) said.

The PBOC cited a strong U.S. dollar and sharp appreciation in the RMB real effective exchange rate as key considerations behind the policy change.

The PBOC said the RMB's central parity has deviated from its actual market rate "by a large extent and for a long duration," which has "undermined the authority and the benchmark status" of the central parity system.

Following the change, the central parity rate of the RMB, or the yuan, weakened sharply to 6.2298 against the U.S. dollar, compared to 6.1162 on Monday, nearly 2 percent lower.

The PBOC described the sharply lower rate as a "one-off" adjustment that has bridged the previously accumulated differences between the central parity rate and the market rate.

The central bank said it would closely monitor market movements in the future to stabilize market expectations and make sure the new exchange rate formation system works effectively.

The PBOC vowed more efforts to promote foreign exchange reform and make it more "market-oriented."

China's foreign exchange reform officially started in July 2005 when the central bank decided to unpeg the yuan against the U.S.dollar and allowed it to fluctuate against a basket of currencies. Endi