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State's forex decision lessens yuan pressures
( 2003-09-08 09:09) (China Daily)

The State Administration of Foreign Exchange has announced that, starting on October 1, the indicative limits on foreign exchange purchases by Chinese residents will be raised. The policy adjustment will better meet the legitimate demands by individual Chinese for forex, and will, to some extent, alleviate the pressure on the renminbi to appreciate.

At present, the upward pressure on renminbi comes from both outside and within. The internal pressure mainly comes from the surpluses on China's current and capital accounts. Since the country joined the World Trade Organization in late 2001, China's exports has risen on a large scale continually, bringing considerable surpluses on its current account.

At the same time, China's good investment environment and relatively high investment returns have drawn in a continuous inflow of overseas capital, which has resulted in capital account surpluses.

Market demand for renminbi thus increases, and appreciative pressure ensues.

On the other hand, there is external pressure. Currently, the United States and Japan are continuously filling the airwaves with rhetoric urging the renminbi to appreciate. On September 2, US Treasury Secretary John Snow arrived in Beijing, marking a climax of the lobbying campaign by foreign forces who advocate the yuan should be allowed to appreciate.

Against such a backdrop, the Chinese Government's loosening part of its forex controls, in the near term, will soothe the appreciative pressure on the renminbi and, in the long run, is an unavoidable step in deepening the financial reform and improving the interest rate determining mechanism of the renminbi.

Announcing a partial relaxation in forex controls before John Snow's visit, to some extent, was a direct response to overseas calls for the yuan to appreciate. The Chinese Government wants to tell the outside that it is not rigid with the exchange rate issue, and it has started to make the exchange rate more flexible.

Such a limited compromise is conducive to pacifying tensions about the exchange rate issue in Sino-US relations, and therefore, reduces some of the external appreciative pressures

If the Chinese Government simply appears indifferent to calls to appreciate the yuan's exchange rate, it will not suffer great economic losses in the near term, but it will be on the defensive politically. This could isolate the nation in future international economic exchanges.

Therefore, the move was a direct response to the lobbying efforts by the US Government, making sure that Mr Snow did not return to his country empty handed. By doing so, (the Chinese Government) soothed external pressures with a small compromise and gained time for preparations for further interest rate system reforms. This was consistent with the government's style in handling the exchange rate issue.

The persistent current account surpluses are one of the internal forces behind the yuan's appreciation. Loosening part of the forex controls can increase forex spending and reduce official reserves, consequently alleviating internal appreciative pressures and helping stabilize the yuan's exchange rate.

The current forex purchase limits already have constrained overseas payment abilities by Chinese residents. Under the old rules, domestic residents were allowed to purchase foreign currency equivalent to US$2,000 when going abroad. With incomes and buying powers of Chinese residents growing, the permitted amounts fell short of citizens' needs for forex.

After the policy adjustment, Chinese residents are now allowed to purchase forex equivalents up to US$3,000 for overseas travel within half a year; for travel longer than half a year, the ceiling is now US$5,000. It is certain that their forex purchases from banks will rise substantially after the adjustment, and China's official reserves will drop accordingly.

According to statistics by Hong Kong's tourism authorities, the average spending by tourists from the Chinese mainland during their visits to Hong Kong was equivalent to 4,000-7,000 yuan (US$481-US$843), which was close to the US$1,000 forex purchase maximum.

According to surveys, more than one-third of such consumption was paid in renminbi. There are other good reasons for the changes, too. One is that many residents wanted to keep the foreign exchanges they had to diversify their assets.

Therefore, raising the ceilings will not only increase overseas spending by Chinese residents to reduce current account surpluses, but also raise forex holdings by individuals and bridle the rapid increases in China's official foreign reserves.

According to the latest joint forecast by MasterCard and Pacific-Asia Travel Association, 6.3 million Chinese mainland residents plan to travel overseas in the coming six months, half of them targetting Hong Kong. If they buy all the US$3,000 forex they are allowed, forex purchases for travels to Hong Kong alone will reach US$9.3 billion for the coming six months, US$6.2 billion more than purchases under the old rules.

It is predictable that the new measure will help create a channel for forex outflows and play an active role in alleviating the upward pressure on the renminbi.

The author is Zhang Peng, a researcher at the Economic Forecast Department of the State Information Centre

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