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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
Email:[email protected]
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 enlarges;85% FDI in East coast
area,3.22% in Western area;non-state-owned entities obtains the
most;the 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?
Net Export from 1978 to 2003
unit:hundreds of millions of US dollar
500
1.2
400
1
300
0.8
200
0.6
100
0.4
0
78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99
0
1
2
3
-100
0.2
-200
0
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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; interes
t rates in US(1%) lower than China.
C.- Various policies to adjust RMB exchange rate would affe
ct.
---To adopt some measures to solve trading conflict
s;
---To accelerate the liberalization of capital cont
rol (QFII,QDII);
---To reduce the tax refund to export firms;
---To rebalance the portfolio of foreign reserve.
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II.Advantages/disadvantages of
current 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 determinatio
n.
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III. Main targets of the reform
A.To maintain the stability of nominal RMB exchange rate agai
nst all other currencies for the stable circumstances for
the continuous
and steady economic growth.
B.To introduce floating system of RMB exchange rate determina
tion
gradually.
C.To switch to a managed floating system against the basket o
f
foreign currencies instead of US dollar only.
D.To establish coherent relationships between domestic moneta
ry 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 fo
reign
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 wou
ld 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 frequen
tly;
B.Unable to avoid the impact of other factor besides the ex
change 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 Macroeconomics:High average GDP per person,
steady economic growth, efficiency of the economy, stabil
ity of prices, healthy public finance, etc.
B.Improvement of corporate governance and healthy microeconomic condition;
C.More efficient financial institutions and financial marke
ts;
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 for
eign
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 threaten
ing 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 !
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