CHINA took another step to degrade the U.S. dollar in defining the value of its currency, in an effort that cuts against its rival’s stubbornly strong hold on the global financial system.

    An arm of the People’s Bank of China, which started setting the yuan against a basket of currencies two years ago, is adding 11 units to that reference group. The move lowers the dollar’s weighting by 4 percentage points to 22.4 percent, little more than twice the share for South Korea’s won, a new entrant.

    While the logic of determining the yuan’s value against the currencies of its trading partners is clear, the problem is that the dollar is still the dominant reference in the perception of the public and the market. The U.S. currency is on one side of 88 percent of all foreign exchange trading.

    “The dollar-yuan rate will still be the benchmark that determines sentiment,” said Hong Hao, chief strategist in Hong Kong at Bank of Communications International Holdings Co. “The basket is just a reference, so the change in the index’s composition and the efforts of keeping it stable will do little to boost confidence.”

    The yuan’s retreat against the CFETS RMB Index, the basket set by the China Foreign Exchange Trade System (CFETS), has been more moderate last year than against the dollar, as the currencies of China’s trading partners have also declined. In recent weeks, it’s even advanced.

    The challenge is that China’s swelling middle class, along with its ultra-wealthy, are looking to diversify some of their increasing pool of savings overseas. Prospects for higher U.S. interest rates only increase the allure of the dollar.

    Simply adding currencies such as the won, South Africa’s rand, the dirham of the United Arab Emirates, Saudi Arabia’s riyal, Hungary’s forint, Poland’s zloty and Turkey’s lira won’t be sufficient to change the public’s view, according to a panoply of analysts from institutions including Royal Bank of Scotland Group, Bank of Communications and ICBC International Research Ltd.

    The background to last week’s announcement: an accelerating outflow of funds that’s seen China’s foreign exchange reserves slide, the central bank’s yuan positions drop in November by the most since January last year. The central bank said Friday it tightened requirements for lenders to report cross-border transactions by customers as part of efforts to curb money laundering.

    “The yuan will continue to depreciate against the greenback and the pressure of capital outflow will likely persist in 2017,” said Hong, who estimates a “fair” rate would be 7.5 per dollar, against 6.9468 in afternoon trading Friday.

    “Adding a batch of emerging market currencies into the basket will likely increase two-way volatility of the yuan’s fixing and the exchange rate,” Ken Cheung, Hong Kong-based Asia currency strategist at Mizuho Bank Ltd., said Friday.

    “If the dollar extends its rally next year, particularly against the emerging market currencies under Donald Trump’s presidency, the onshore and offshore yuan will come under heavier pressures.”

    The CFETS said Thursday that the weighting of the yuan’s basket will be evaluated on an annual basis and updated at the “appropriate time.” The dollar and currencies that are pegged to the greenback, such as the riyal and the Hong Kong dollar, will take up 30.5 percent of the new basket, down from 33 percent currently. The won will make up 10.8 percent.

    The changes started with the turn of the year. Also kicking in at that time: the renewal of citizens’ US$50,000 quota of foreign currency purchases. The likelihood of further Federal Reserve rate hikes, and concern that U.S. President-elect Donald Trump will slap punitive tariffs on China’s exports, are adding to the challenges looming over policymakers.(SD-Agencies)