pubP-711

REFORMS OF THE EXCHANGE RATE REGIME: THE CHINESE EXPERIENCETAO ZHANG : 

REFORMS OF THE EXCHANGE RATE REGIME: THE CHINESE EXPERIENCETAO ZHANG PEOPLE’S BANK OF CHINA

INTRODUCTION : 

INTRODUCTION Exchange rate, capital control, and monetary policy Globalization poses challenges to choosing policies that are shaping exchange rates，capital control， and monetary policy: impossible trilogy? The rising cost of capital control and its ineffectiveness

OUTLINE : 

OUTLINE Policy concerns The international experience of the choice of exchange rate regimes Reform in China Future of RMB

Policy Concerns : 

Policy Concerns Key concerns of developing countries Fixed exchange rate system is not consistent with the independence and flexibility of monetary policy Challenges to capital control: transition from a highly restrictive system to one that is more appropriate to a changing economy

International experiences : 

International experiences IMF: current statistics Historical changes

Statistics at IMF（187 member countries) : 

Statistics at IMF（187 member countries) Source:Annual report on exchange arrangement and exchange restrictions 2004

Slide 7: 

Historical changes Source:A.M. Husain et al., 2004

Exchange rate regime not permanently set : 

Exchange rate regime not permanently set 1970s: from Peg to float (Canada, Australia)） 1990s:from float to peg (EU, Poland) Denmark: Peg (post-WWII)；1970s: float；after 1985：back to peg

Regime Durability(Average # of years until regime transition takes place)（1975-2001） : 

Regime Durability(Average # of years until regime transition takes place)（1975-2001） Source:A.M. Husain et al.,2004 from Reinhart and Rogoff,2003)

RMB: the Chinese experience : 

RMB: the Chinese experience Evolution of the RMB regime The new regime

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0 2 4 6 8 10 12 1979.01 1980.01 1981.01 1982.01 1983.01 1984.01 1985.01 1986.01 1987.01 1988.01 1989.01 1990.01 1991.01 1992.01 1993.01 1994.01 1995.01 1996.01 1997.01 1998.01 1999.01 2000.01 2001.01 2002.01 2003.01 2004.01 Int.transaction rate Official rate Swap market rate Unified inter-bank rate 1979 ,FX retention systen 1994 unified with the exchange rate Dual rate China: evolution of foreign exchange rate system

Evolution of the RMB Exchange Rate System : 

Evolution of the RMB Exchange Rate System 1980s, a fixed exchange rate system plus frequent RMB devaluation 1988-1993, a dual exchange rate system: official fixed exchange rate coexisted with the market-determined rate in the swap centers The swap market rate depreciated sharply in the early 1990s 1994, the official rate was devalued and unified with the exchange rate at the swap centers; 1995, a de jure managed floating exchange rate system although the currency has been de facto fixed to $ 2004(21 July): Managed floating

Policy challenges : 

Policy challenges More difficult maintaining external balances, especially trade balances Constraints for developing abilities of competition by domestic firms Increased uncertainty with $ Limited freedom for independent monetary policy

Preparing reforms : 

Preparing reforms Bank sector reforms Deepening of the foreign exchange market Relaxed foreign exchange control

Banking sector reforms : 

Banking sector reforms 1998/99，270 billion Yuan (about 33 b$) capitalization for SOBs; 4 AMCs established, managing 1.4 trillion Yuan NPLs 2003-2005, CCB, BOC, and ICBC financial restructuring 2003, rural credit institutions reforms started 70-80% of banking institutions now restructured

Deepening foreign exchange market : 

Deepening foreign exchange market Transition of foreign exchange settlement system from forced to voluntary Raised retention ratio for domestic firms Raised ceilings for domestic residents to purchase foreign exchange when travel abroad May 2005, inter-bank foreign exchange pair trading launched

Relaxed foreign Exchange control : 

Relaxed foreign Exchange control Less constraints on current account transactions for both individuals and firms Easy market entry and business operations

Favorable macro-economic developments : 

Favorable macro-economic developments Strong growth Moderate inflation Rising dollar interest rates Strong external demand Strong dollar and moderation of Euro and Yen

But there are disturbances… : 

But there are disturbances… An issue being politicalized Loss of focus: bilateral balance Rising trade protectionism …encouraged market speculations

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The new exchange rate regime: 21 July Initial level “adjusted to” Y8:11 per US$: Taking into account trade balance and structure, and impact on domestic firms A 0.3% range of fluctuation for $ rate; For non-$ rates, 1.5%; subsequently (23/09) widened to 3.0%.

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But it is more a change of regime (managed floating) rather than level Stop of a de facto US $ peg; A basket-currency-based, but not pegged More market-based; Pre-set adjustment: 2%

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Explaining 2% Average trade surplus at about 2% of GDP in 2000-2004 The 2% adjustment hoped to help restore trade balance, but in part only Minimize shocks to domestic firms

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Basket currencies Basket-currency-based (referenced), but not peg Changes in the basket currencies serve as reference for bench-mark rate and range of fluctuation International balance: weaker link Not directly related to bilateral

Slide 24: 

Composition of the basket currencies Emphasis on merchandise trade and services: $10b above: has to be included $5b above: important to consider US$, Euro, Japanese Yen, Korean Won, Other currencies:Sin, UK, MAL; and Rus, Australia, Thai, Canada, etc Also factors of concern: origins of external debts consideration of origins of FDI (balance $560b) consideration of balance of income transfers

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Understanding “gradualism” Following the pattern of the overall market-based reform process witnessed in the past 20 years Continuation of earlier efforts 1980’s: dual rate system; FX retention system; unified inter-bank FX market 1994: unified FX rates 1996: current account convertibility

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Why not immediate float? Not prepared well: global economic imbalances and uncertainties; large amount of cross-border capital flows Necessary regulatory role of state for a large transition economy Central bank: filtering abnormal fluctuations

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Preliminary assessment of the new regime More fluctuations? Responses of firms Revaluation pressure

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Fluctuations Fluctuations less than expected Two way movements: beating market expectation 22/07 to 21/09: up to 8.1128 and down to 8.0871 (a range of 257bp) compared with 10+ bp for the whole year pre-reform

Slide 29: 

Firms’ responses Spot transaction (RMB vs foreign currencies): smaller surplus (15% down) in August (m-t-m) Forward transactions: more active (both purchase and sale doubled in Aug y-o-y) But more firm purchase (up 52%) and less sale m-t-m (down 23%) Overall, limited impact on exporting firms in the short run Little impact on FDI

Slide 30: 

Pressure on revaluation? Immediate impact NDF discount: from 4111 22 July narrowed to 2750 end Aug, in line with the interest rate difference between LIBOR and CHIBOR But still 60% of the surveyed exporting firms hold expectations of further revaluation

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Follow-up measures More relaxed foreign exchange management: higher ratio of retention rate (30-50% to 50-80%) Further easiness of market entry: more non-bank and non-financial firms allowed for the inter-bank marke transaction Inter-bank forward transaction system introduced

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Sept 23 measures Not a change of the new regime adopted 21 July: a technical step Expansion of floating band vs. non-$ only, help banks to better control risk by reducing arbitrage opportunities Widening of buying-selling range follows international practice and discourages speculation

Slide 33: 

The future of RMB Short-term objectives: Improving the managed floating regime Less administrative measures determining the exchange rate As economic fundamentals and market infrastructure improve, range of fluctuation will be allowed to expand Institutional support for new product development like derivative products Forward transactions recently introduced; more on swaps, options More on interest rate liberalization

Slide 34: 

RMB: Long term Objectives Consistency in the overall economic reform framework: building a market-based economy Improving foreign exchange regime: A market-based managed floating regime Eventual convertibility Maintaining the RMB stability which reflects the appropriate and equilibrium level Supported by relaxed c/b capital movements in a selective and phased manner

Slide 35: 

RMB: only A policy instrument RMB: only partly affect the Chinese external balance Change of development strategy is more crucial Domestic consumption is key Structural policies face challenges

Slide 36: 

Key structural issues Too much reliance on exports and investment Rapidly expanded trade surplus Direct financing remains weak Consumer credit policy; min. wages; social securities, personal income tax; Urbanization and rural development Financial sector reforms

Slide 37: 

SUMMARY International experiences point to a trend of reform in exchange rate regimes, particularly for emerging economies But the way of reforms is not universal The short-to-medium-term objective of the Chinese RMB reforms emphasize is a more market-responsive managing floating Plus a gradual realization of full currency convertibility The RMB policy serves the overall macroeconomic policy objectives; not just external surplus

THANK YOU : 

THANK YOU