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Forex system must be overhauled
( 2003-08-10 08:01) (China Daily)

There are signs that Chinese authorities are considering developing a more flexible foreign exchange mechanism and a handful of measures to alleviate pressure to appreciate the currency.

The central bank "should reform the exchange rate system to create conditions for changing the formation mechanism of the renminbi's exchange rate," Li Yang, head of the financial research institute at the Chinese Academy of Social Sciences, said last week.

But Li, also a member of the central bank's monetary policy committee, stressed the current exchange rate is "sustainable," and "tallies with China's macroeconomy."

Zhou Xiaochuan, governor of the People's Bank of China (PBOC), the central bank, expressed a similar view last month.

He suggested China must "perfect" the exchange rate mechanism.

Dai Genyou, head of PBOC's monetary policy department, was quoted by Financial Times late last month as saying "the size of the fluctuation of the exchange rate is, in the final analysis, the natural result of the market."

Such remarks, by high-profile central bank officials, have been widely interpreted as signs authorities, while vowing to maintain a stable yuan, might consider adjusting the unit's trading band.

The renminbi, currently, is virtually pegged to the US currency, with a tight band restricted to between 8.276 and 8.280 to US$1.

"By creating a wider range for the yuan to fluctuate, the government would show its willingness to let market forces determine the currency's exchange rate, whether it would appreciate or depreciate," said a financial expert, who refused to be named.

"This would, to a degree, lessen international pressure to revaluate the yuan."

More freedom for the yuan to float would mean less intervention by PBOC in the yuan's exchange rate in the currency market, experts said.

This would make China better able to withstand pressure, in terms of both political and economic pressures, from its trade partners, they said.

Indeed, international pressure has intensified in the past two weeks, as top US officials joined the chorus of people urging the Chinese Government to reconsider its exchange rate system.

Earlier requests had been made by Japan, South Korea and other Asian countries.

US Treasury Secretary John Snow said last Thursday he was unsure if the yuan was undervalued, but said the US Government should "encourage" China to "look at widening the band."

Also last month, Alan Greenspan, chairman of the US Federal Reserve, said China would have to let the renminbi float.

Supporting the currency requires the PBOC to be "very heavy purchasers of US dollar-denominated assets," he added.

UBS, one of the world's leading financial firms, estimates China has purchased about US$27 billion worth of the US currency on the foreign exchange market this year to curb the yuan's upward trend.

China's bilateral trade surplus last year with the United States ballooned to US$100 billion. China's exports to the United States between 1997 and last year more than doubled.

Exports have helped China establish its record foreign exchange reserves, US$346.5 billion, most of which have been invested in US treasury bonds, experts said.

China is expected to adopt other measures to ease pressures for it to revalue the yuan, sources said.

Allowing greater flexibility to convert the yuan on the current account could be one measure, experts suggest.

That would mean Chinese citizens would have more freedom to buy currencies for travelling, and it could result in the establishment of a nationwide foreign exchange market.

"The move would make China's increasing reserves more balanced, given China's foreign exchange system is still under rigid control," Li Qingyuan, an economist with Peking University, told a recent seminar.

Reducing export-tax-rebate rates could be another option, sources said.

Such a move, most likely early next year, would cut the rebate rate by 4 per cent.

The current tax rebate, an average 15.5 per cent, was set in the late 1990s during the Asian financial crisis as Chinese officials tried to boost the nation's export sector.

"Either reducing rebates or appreciating the yuan would affect the export sector," said Zhang Tianming, a senior consultant with China International Tax Consultancy Co.

"But the latter would likely have a much more severe impact, and cause more damage to China's economy."

The country needs to create more than 20 million jobs a year over the next decade to cope with urbanization, experts suggest.

Although the severe acute respiratory syndrome (SARS) outbreak in the year's first half has had less impact on China's GDP (gross domestic product) growth than first thought, economists worry it might take longer than expected for the service industries to recover from the epidemic.

A quick appreciation of the yuan would be too risky for China's financial system, in which bad loans account for more than 20 per cent of banks' assets.

Many scholars link the repeated calls for China to revalue the yuan to the "Plaza Accord" drafted in the mid-1980s.

The accord, signed by the Japanese Government, allowed the yen to appreciate. However, it also pushed up Japan's labour costs and seriously affected the country's competitiveness in exports.

The so-called "hollowing-out" process has left Japan's economy in a seemingly endless abyss of deflation, many economists suggest.

The fear a similar fate awaits China if the yuan appreciates is one reason why Chinese officials repeatedly shrug off international pressure to adjust the currency.

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