The debate on changes to the renminbi exchange rate has continued for many
years.
Despite the fact that the central bank's renminbi exchange rate reform
initiated from July 21, 2005 has won widespread support from both domestic and
overseas financial circles, some continue to call for a further appreciation of
the renminbi and a more flexible exchange rate. According to those people
(especially those in the US), both China and the United States will benefit if
Beijing relaxes its "rigid" currency regime and increases the flexibility of its
exchange rate.
In their opinion, this would also accelerate China's transition to a market
economy and guarantee the nation's long-term and sustainable prosperity.
China, however, must not show undue haste in the reform of its foreign
exchange management regime.
Following the first adjustment to the renminbi exchange rate last July, China
still has a trade surplus, a huge foreign exchange reserve and a fast growing
economy factors which require a revaluation of the renminbi, according to some
Western analysts. Although foreign pressure for renminbi revaluation eased
somewhat in the wake of the adjustment, many people continue to call for a
readjustment of the Chinese currency's exchange rate.
Facing this pressure, the Chinese authorities have continued to keep a close
eye on changes in foreign exchange markets and have taken initiatives to conduct
systematic reforms, after taking into consideration both the domestic and
international economic situations.
What many analysts and foreign governments should have noticed is that last
year's renminbi reform was not merely an isolated adjustment of the currency's
exchange rate, it was a comprehensive reform of the renminbi exchange rate's
formation mechanism.
Since last July, a series of systematic adjustments have been made to reform
the renminbi exchange rate system. For example, Chinese residents have been
allowed to buy more foreign currency and the procedure has been simplified;
various risk-prevention instruments and products for enterprises have been
launched, such as forward foreign exchange swaps; the floating range between the
renminbi and non-US dollar foreign currencies has been widened; renminbi
services have been allowed to expand in Hong Kong; the mechanism for channelling
renminbi back across the boundary has been strengthened; the market-maker system
has been encouraged; and eligible domestic banks, funds and insurers have been
allowed to invest overseas.
These measures point to the continued reform of the renminbi exchange rate
formation mechanism. The Chinese authorities will closely monitor the operation
of the current renminbi exchange rate mechanism to prepare for further
improvements to its formation mechanism.
It should be noted that a change in the renminbi exchange rate is not what
decides the trade balance between China and its trade partners. In addition, it
will not prevent the further growth of China's foreign exchange reserve.
The key factors behind China's foreign trade surplus include a large supply
of low-cost labour, in addition to improvements in skills and China's overall
productivity and technological level. This surplus is also a consequence of
continually falling transaction costs resulting from various institutional
reforms.
Given these factors, Chinese-made products will remain internationally
competitive for quite some time.
China's fast-expanding foreign exchange reserve is related to its trade
surplus to some extent, but the main cause is its underdeveloped financial
system and market, which has failed to make use of the capital to hire redundant
labourers.
The reform of the renminbi exchange rate regime will be a long-term project
requiring progress in the reform of China's overall financial system.
For example, China imposes strict capital controls and splits the foreign
currency market from the renminbi market. As a result, while the US dollar's
interest rate has been rising continually, the renminbi interest rate has not
changed much. The interest rate gap has been widening. According to the general
interest rate parity theory, capital should flow from countries with low rates
to those with higher rates. However, given the split currency market, Chinese
individuals and companies cannot hold US dollars or sell renminbi freely.
This market segregation and the outdated system of exchange settlement and
sales not only restricts Chinese individuals', enterprises' and foreign
investors' arbitrage, but has led to a worsening of China's balance of
international payments and the growth of its foreign exchange reserve.
Therefore, giving the fast-growing foreign exchange reserve and expectations
of a revaluation of the renminbi, the issue of the renminbi exchange rate is
related to the separated foreign and domestic currency markets. It is of vital
importance to establish a unified currency market to further improve our
renminbi exchange rate formation mechanism.
On the other hand, while trying to slow the growth in the foreign exchange
reserve, we need to reflect on our export and foreign capital introduction
policies, such as the export tax rebate policy, favourable policies for foreign
investors and the existing capital account regulation.
On that basis, we should take the initiative to make the renminbi an
international currency. Issuing renminbi-denominated bonds, for example, can be
considered, so the hot money entering China to speculate on renminbi revaluation
can be diverted to the renminbi-denominated bond market to alleviate pressure on
the Chinese currency. The move would also help unify the foreign and national
currency markets and improve the renminbi exchange rate formation mechanism.
It is very difficult to predict how the renminbi exchange rate will fluctuate
in the future. Meanwhile, China may continue to suffer from trade frictions with
its major trade partners and see a further expansion of its foreign exchange
reserves.
Facing those challenges, China is expected to push, in accordance with its
own agenda, the reform of the renminbi exchange rate formation mechanism to make
it more rational and flexible.
The author is a researcher with the Institute of
Finance and Banking of the Chinese Academy of Social Sciences.
(China Daily 07/21/2006 page4)