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Evolution of renminbi exchange rate regime
(China Daily)
Updated: 2004-10-11 09:13

The renminbi exchange rate issue has been at the centre of trade disputes between China and its major trading partners during the past year. It is also a key factor in China's ongoing macro management efforts.

Guo Shuqing, director of the State Administration of Foreign Exchange and deputy governor of the People's Bank of China, the nation's central bank, shares his views, as a scholar, on this issue in an article published on the September issue of Foreign Exchange magazine.

Staring today, China Daily will publish the article in five parts, focusing respectively on the evolution of the renminbi exchange rate regime and the relationships between the exchange rate and foreign trade, employment, industrial structure and capital flows. The fifth part will also contain the director's conclusions.

Following is the first part - the evolution of the renminbi exchange rate regime.

Since China embarked on its reform and opening-up policy in 1979, the renminbi exchange rate regime has undergone transformations from a single official rate to a dual-track system, and then to a single market rate.

The 1997 Asian financial crisis had a significant impact on the renminbi exchange rate forming mechanism.

The renminbi exchange rate system has experienced three phases since the start of the reform and opening-up policy.

First phase: 1979-93. The renminbi exchange rate, used as a tool for financial planning under the planned economy, was long fixed at overvalued levels. Therefore, the renminbi exchange rate was devalued repeatedly over a fairly long period of time after the start of the reform and opening-up policy to meet the needs of reform and economic growth.

A dual-track system, with both the official exchange rate and one for foreign trade-related internal settlement, was gradually developed, while the foreign exchange swap market rate was introduced later.

The official renminbi exchange rate was lowered to 580 yuan per US$100 at the end of 1993, down 73 per cent from the 158 yuan per US$100 level at the beginning of 1979.

Meanwhile, the average renminbi exchange rates against major trading partners, or the nominal and real effective exchange rates, slid by 68 per cent and 76 per cent respectively.

Second phase: 1994-97. The official renminbi exchange rate and the foreign exchange swap market rate were integrated on January 1, 1994, starting a market-based, managed floating rate system.

Although the official exchange rate was lowered by 33.3 per cent upon the integration, real devaluation of the currency was 6.7 per cent given the fact that 80 per cent of forex transactions then were done in the swap market.

The rate integration changed the long-standing situation of renminbi overvaluation and, therefore, reversed a persistent trend of decline. The renminbi strengthened by 4.8 per cent against the US dollar from 1994 to the end of 1997. Taking into account the rapid domestic price increases between 1994 and 1995, the real appreciation of the yuan against the US dollar was 39 per cent.

Meanwhile, the renminbi's nominal and real effective exchange rates rose by 10.2 per cent and 38.7 per cent respectively.

Third phase: 1998 to date. Strong expectations for a yuan devaluation emerged in the marketplace in 1998 as the Asian financial crisis deepened, amplifying capital outflows.

In a bid to prevent the crisis from spreading further, the Chinese Government made a commitment to not devaluing the renminbi, keeping it at the 828 yuan per US$100 level. That made a significant contribution to buttressing the economic and financial stability of Asia and the world.

Shortly after initial results were achieved in the nation's efforts to tackle deflationary pressures, there came the external and internal shocks of the September 11 terrorist attacks, the global economic recession and the outbreak of the severe acute respiratory syndrome epidemic. China maintained the consistency in its exchange rate policy and continued to enforce the relatively narrow range for the renminbi exchange rate.

Although the change in renminbi exchange rate against the US dollar was fairly small during this period, it was not so against other currencies.

Between 1998 and 2001, with most of the world's currencies weakening against the US dollar, the yuan became one of a few strong emerging market currencies. Renminbi's nominal and real effective exchange rates rose by 11.5 per cent and 9.8 per cent respectively.

After 2002, the renminbi exchange rate softened along with the US dollar's adjustment. By the end of 2003, the renminbi's nominal and real effective exchange rates fell by 12.3 per cent and 11.0 per cent respectively.

Speaking of the overall situation, the renminbi exchange rate, either on a bilateral or multilateral basis, was on a downward spiral before the rate integration. But afterwards, it became relatively flexible, moving in different directions against different currencies to varied degrees.

Although the renminbi, following the US dollar, has somewhat edged down in recent months, it remains on an upward trend.

The renminbi's nominal and real effective exchange rates rose by 6.7 per cent and 31.5 per cent between 1994 and 2003. In nominal terms, the currency strengthened by 5.1 per cent and 10.3 per cent against the US dollar and the Japanese yen respectively, while the real appreciation was 20.1 per cent and 59.1 per cent considering inflation differences.

A few basic facts can be drawn from the above.

The evolution of China's exchange rate system was market-driven. Although there have been interferences from external factors, the direction has not been changed

The renminbi exchange rate kept falling in the early years of reform, but has been on a stable uptrend over the past 10 years

Compared with China's trading partners, the renminbi's average exchange rate has seen a lot of fluctuations. It appreciated by more than 20 per cent in the recent 10 years, or nearly 60 per cent if inflation is taken into account

The narrowing in the renminbi exchange rate floating range after 1997 not only benefited China, but also was what Asia and the world needed

China has never manipulated its currency, because by pegging to the US dollar, the exchange rate has had both ups and downs, making it impossible to always benefit from improved price competitiveness in export commodities, let alone any other extra benefits.

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