The Reform Initiatives of RMB Exchange Rate Determining Mechanism

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The Reform Initiatives of RMB Exchange Rate
Determining Mechanism

• April 1st, 2004
• Cao Honghui
• Institute of Finance Banking
• Chinese Academy of Social Sciences

Emaildavidcao2002_at_163.com
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Contents

• I. Why reform RMB exchange rate ?
• II. Advantages disadvantages of current RMB
  exchange rate determination mechanism
• III. Main targets of the reform
• IV. Main contents of the reform
• V. Advantages and disadvantages of the basket
• mechanism
• VI. Further measures to be taken

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I.Why reform RMB exchange rate determination
mechanism?

• 1.Strong expectation for the increase of RMB
  exchange rate
• A.Rapid growth of international
  income/expenditure balance
• Sheet,capital flow reaches US dollar 100
  trillions,obtaining
• 80 of GDP of China.
• B.No systematic risks of debt,foreign debt
  reaches US dollar
• 43.2 billions in 1998,30.4 billions in 2002,and
  decreases 16.1 in
• 2003.
• C.FDI slows down though the scale enlarges85
  FDI in East coast
• area,3.22 in Western areanon-state-owned
  entities obtains the
• mostthe gap of service trading enlarges.
• D.Why net capital flow increases?
• ----QFII leads to the capital flow(US dollar
  1.7 billions) into
• domestic market

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I.Why reform RMB exchange rate determination
mechanism?

• ---More enterprises IPO overseas in 2003
• ---Private sector draws back the foreign currency
  in
• advance and the overseas foreign currency
• ---The foreign currency savings of inhabitants
  decreases US
• dollar 1.9 billions in 2001,increases 7.7
  billions in 2002
• and 10.7 billions in 2003
• ---Foreign reserve increases 150 billions in
  inter-bank
• foreign currency market in 2003
• ----Gross foreign reserve reaches 330.3 billions
  in 2003.

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I.Why reform RMB exchange rate determination
mechanism?
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I.Why reform RMB exchange rate determination
mechanism?

• 2. Some explanations
• A.From international side
• ---Globalization accelerates the adjustment of
  industries
• which results in the increase of manufacturing
  trading.
• ---Limitations of techniques from developed
  countries.
• ---Unfairness in international system.
• B.From domestic side
• ---high ratio of savings/investment
• ---large surplus of capital owing to financial
  restriction

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I.Why reform RMB exchange rate determination
mechanism?

• 3. New development
• A. Net export was US dollar 7.9 billions at the
  first two
• months of 2003.
• B. -Impact of interest rate from US would
  increase interest rates in US(1) lower than
  China.
• C.- Various policies to adjust RMB exchange rate
  would affect.
• ---To adopt some measures to solve
  trading conflicts
• ---To accelerate the liberalization of
  capital control (QFII,QDII)
• ---To reduce the tax refund to export
  firms
• ---To rebalance the portfolio of foreign
  reserve.

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II.Advantages/disadvantages ofcurrent RMB
exchange rate determination mechanism

• 1.Advantages of current RMB
  exchange rate systems
• A.Good for the stable expectation of RMB exchange
  
• rate in foreign trading investment.
• B.Good for the stability of the value of foreign
  
• currency Assets.
• C.Good for the internationalization of RMB.
• D.Good for the stability of East Asian currency.
• E.Good for the stability of CPI in the mainland
  of
• P.R.China.

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II.Advantages disadvantages of current RMB
exchange rate determination mechanism

• 2. Disadvantages of current RMB exchange
  rate systems
• A.Unable to reflect the inner need of domestic
  economic
• development to adjust exchange rate.
• B.Unable to maintain both domestic and
• overseas equilibrium,which is necessary to
  maintain the
• continuous economic growth.
• C.Fixed against US dollar is not conducive to the
  stability of the nominal exchange rate of RMB
  against other currencies

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II.Advantages disadvantages of current RMB
exchange rate determination mechanism

• 3.Three methods to eliminate RMB
  revaluation expectation
• A.Public announcement to maintain exchange rate.
• The measures to decrease the pressure can just
  eliminate
• some contortion in economy,but cannot entirely
  eliminate
• the long term expectation for the increase of RMB
  exchange
• rate.
• B.To increase RMB exchange rate in a wider band.
• The immense impact of it to the stability of
  domestic
• as well as world economic growth cannot be
  expected and
• controlled.
• C.To reform the mechanism of RMB exchange rate
  determination.

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III. Main targets of the reform

• A.To maintain the stability of nominal RMB
  exchange rate against all other currencies for
  the stable circumstances for the continuous
• and steady economic growth.
• B.To introduce floating system of RMB exchange
  rate determination
• gradually.
• C.To switch to a managed floating system against
  the basket of
• foreign currencies instead of US dollar only.
• D.To establish coherent relationships between
  domestic monetary policy and exchange rate policy.

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IV. Main contents of the reform

• 1.Realistic option for RMB exchange rate
  reform
• A.Under the stability of RMB exchange rate,to
  enhance the
• elasticity of it by two ways
• ---To enlarge the floating band of RMB exchange
  rate
• ---To switch to the managed floating system
  against a basket of foreign
• currencies instead of US dollar only.
• B.Why not the first but the second choice?
• ---The central exchange rate needs to be
  adjusted always under the first option
• ---The revaluation expectation would push it
  to the ceiling if the band is
• too narrow, which is similar to one time
  adjustment of exchange rate.
• ---While if it is so wide, the fluctuation of
  exchange rate would strongly impact the economic
  growth and stability.

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IV. Main contents of the reform

• 2.Measures to be taken to establish the
  basket
• A.To choose ten currencies of the main economies
  which have
• the closest trading and investment relationship
  with P.R.
• China.
• B.To establish different weight for each chosen
  currency.
• C.To adjust the weight according to the changes
  of trade
• and investment between these countries and China.

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V. Advantages and disadvantages of the basket
mechanism

• 1. Advantages of the
  basket
• A.To enhance the elasticity of RMB exchange rate
• B.To reduce the unfavorable impact to economy
• C.To eliminate the revaluation expectation of RMB
• 2. Disadvantages of
  the basket
• A.To allow the central bank to adjust exchange
  rate frequently
• B.Unable to avoid the impact of other factor
  besides the exchange rate
• C.Not a long term solution as a system need to
  frequently adjust
• the basket

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VI.Further measures to be taken

• 1. Conditions for Further Liberalization
  of Capital Account
• A.Improvement of MacroeconomicsHigh average GDP
  per person,steady economic growth, efficiency of
  the economy, stability of prices, healthy public
  finance, etc.
• B.Improvement of corporate governance and healthy
  micro-
• economic condition
• C.More efficient financial institutions and
  financial markets
• D.Stable and efficient RMB exchange rate and
  interest rate
• determination mechanism

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VI.Further measures to be taken

• 2.More market force for exchange rate
  determination mechanism
• A.Continue to make the actual supply of the
  market meet the
• actual demand.
• ---To eliminate the restrictions to the
  purchase/sales of foreign
• currency
• ---To promote the liberalization of capital
  account to realize the actual
• demand of residents and non-residents for
  foreign currency.
• B.To reduce the need for the central bank to
  intervene FX too
• frequently
• C.To an eventual flexible exchange rate system
  without threatening the stability of the economy

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Conclusions

• - RMB exchange rate determining mechanism
• should be reformed according to its economic
• growing status,liberalization of financial system
• and market reform.
• - Otherwise,it may be harmful to domestic
• economic growth and stability as well as
  regional
• and even world economic stability.

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Institute of Finance Banking,Chinese Academy
of Social Sciences

• Thank You !