Chinas Exchange Rate System after WTO Accession: Some Considerations

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Chinas Exchange Rate System after WTO Accession
Some Considerations

• Jian-Guang Shen,
• Bank of Finland
• Institute for Economies in Transition

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Chinese RMBs exchange rate, per US
3
Chinese RMBs real effective exchange rate
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Chinas exchange rate system

• Dual exchange rate regime prior to 1994
• Single exchange rate since 1994
• Nominally a system of managed floating exchange
  rate
• Practically a peg to the US dollar supported by
  comprehensive, direct capital account controls.

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Chinas exchange rate market

• The nation-wide inter-bank foreign exchange
  market, the China Foreign Exchange Trading Centre
  (CFETC)
• All foreign exchange trading has been conducted
  in this market. The CFETC also provides
  settlement services
• Over 300 foreign exchange banks and non-banking
  financial institutions

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Problems with Chinas exchange rate market

• Only financial institution headquarters hold
  CFETC memberships
• Dominated by the PBOC and BOC
• Capital control regulations suppress supply and
  demand
• Centralised trading system has high costs and
  restrictions
• Only three foreign currencies (USD, HKD, JPY), no
  futures and options

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Chinas capital control measures I

• Capital brought in from abroad must be deposited
  in special accounts in designated banks. Any
  repayments and remittances from these accounts
  are also subject to SAFE approval.
• Foreign investment in the Chinese stock market is
  limited to B shares. Inbound foreign capital must
  get SAFE approval to convert to RMB.
• All long-term foreign borrowing (over one year),
  including project loans, must be mentioned in the
  comprehensive state commercial loan plan. These
  loan contracts need to be approved by SAFE, which
  assesses the core contents of all mid- to
  long-term commercial loans. Based on the
  financial institutions assets and liability
  condition, SAFE can suggest a distribution plan
  among various financial institutions, and set
  individual foreign exchange loan ceilings for
  each financial institution.
• For short-term foreign debts (less than or equal
  to one year), SAFE assigns foreign debt balance
  quotas to designated financial institutions. Each
  financial institution can borrow from abroad,
  under supervision, without loan-by-loan approval
  of local SAFE branches.
• For commercial loans of less than three months
  under current accounts, SAFE approval is not
  required. Commercial loans of longer than three
  months but less than or equal to one year have to
  be registered with SAFE, and the conditions for
  repayment of principal and interest rates must be
  approved by SAFE.
• Only PBOC-approved state organisations can issue
  bonds abroad. The size of these issues is
  determined in accordance with the state foreign
  capital utilisation plan.
• Leasing and trust loans from abroad are subject
  to local- and national-level plans for
  technological upgrades and foreign capital
  utilisation. Such loans may not exceed the
  foreign exchange quotas set for the enterprises
  involved and must be registered with SAFE.
• All foreign loan guarantees require SAFE
  approval. Only authorised financial institutions
  and enterprises are allowed to provide foreign
  exchange loan guarantees. The amounts to be
  guaranteed are subject to strict conditions.
• Outbound foreign investments by domestic
  enterprises must receive SAFE approval.
• Industrial production up 10.8
• Private consumption up 10.3
• Total investment up 15.1

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Chinas capital control measures II

• All long-term foreign borrowing (over one year)
  must be mentioned in the state commercial loan
  plan.
• Commercial loans of longer than three months but
  less than or equal to one year have to be
  registered with SAFE, and the conditions for
  repayment of principal and interest rates must be
  approved by SAFE.
• Only PBOC-approved state organisations can issue
  bonds abroad. The size of these issues is
  determined in accordance with the state foreign
  capital utilisation plan.
• Leasing and trust loans from abroad are subject
  to local- and national-level plans for
  technological upgrades and foreign capital
  utilisation. Such loans may not exceed the
  foreign exchange quotas set for the enterprises
  involved and must be registered with SAFE.
• All foreign loan guarantees require SAFE
  approval. Only authorised financial institutions
  and enterprises are allowed to provide foreign
  exchange loan guarantees. The amounts to be
  guaranteed are subject to strict conditions.
• Outbound foreign investments by domestic
  enterprises must receive SAFE approval.

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Chinas capital control measures III

• Only PBOC-approved state organisations can issue
  bonds abroad.
• Leasing and trust loans from abroad are subject
  to state plans for foreign capital utilisation.
• All foreign loan guarantees require SAFE
  approval.
• Outbound foreign investments must receive SAFE
  approval.

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Results of Chinas capital control measures

• Chinas foreign debt structure is dominated by
  medium- and long-term foreign debt
• Short-term foreign capital inflows usually are
  part of commercial deals
• State sovereignty debts are significant

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Four alternatives benefits and disadvantages

• Fixed exchange rate regime
• Crawling peg
• Float within bands (target zone)
• Managed float with no pre-announced exchange rate
  path

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Long term goal

• A flexible exchange rate mechanism with free
  cross-border capital mobility
• The role of RMB in the international financial
  market

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Manage the transition

• The exit strategy
• No depreciation pressure
• join a net capital flow situation
• China satisfies both, but worries about
• Appreciation pressure
• the pace of liberalization in accordance with
  other financial market development

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The fixed exchange rate system

• Benefits
• Stable currency
• As nominal anchor for monetary policy
• Prevent currency risks

• Disadvantages
• Inflexible in the face of shocks
• No monetary autonomy under capital liberalisation
  
• prone to currency crisis

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Floating regime

• Disadvantages
• Strong fundamentals needed
• Excessive currency risks
• Interest rates still fixed by PBOC
• More developed financial markets needed

• Benefits
• Flexible in the face of shocks
• Monetary autonomy under capital liberalisation
• Not prone to currency crises

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Floating within bands

• Disadvantages
• Vulnerable to speculative currency attacks
• Difficult to decide the band
• Now RMB has revaluation pressure

• Benefits
• Some flexibility in the face of shocks
• Less strong fundamentals needed
• Avoid excessive currency risks

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Crawling Peg

• Disadvantages
• Vulnerable to speculative attacks
• Crawling rule difficult to design
• Low monetary autonomy and credibility

• Benefits
• Relatively stable currency
• Some flexibility in the face of shocks

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Capital account liberalisation in China

• The effect of WTO accession
• Liberalisation of financial markets
• Money market
• Capital market
• Foreign exchange market
• Operational difficulties
• Commercial banks
• Domestic enterprises
• The central bank

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Capital account control still useful

• The second-best argument compensation for
  imperfect markets in China
• Increased risks in the financial system the
  lesson of the Latin American and Asian Crises
• Assistance for monetary and fiscal policies

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Conclusions

• WTO membership needs more flexible exchange rate
  system
• China as a large continental-type economy
• Capital account liberalisation inevitable
• More shocks require it