The People's Bank of China has just announced that with authorization of the State Council, China will reform the RMB exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies, effective on July 21, 2005. The spokesman of the People's Bank of China has answered the following questions in an interview with the media.
1. How has China's exchange rate regime evolved so far?
Before 1994, China had in succession adopted the fixed exchange rate regime and the "dual " exchange rate regime. After the unification of exchange rates in 1994, China has since adopted the managed floating exchange rate regime based on market supply and demand. Under such a regime, both the enterprises and individuals sell to and buy foreign exchange from the banks, and the banks are engaged in the inter-bank foreign exchange transactions, leading to the formation of the market exchange rate. The central bank set a specified band within which the exchange rate is allowed to float, and make market interventions to maintain the RMB exchange rate stable. Experiences have proved that such an exchange rate regime has been consistent with China's national conditions and thus has made positive contributions to the sustained and fast growth of the economy as well as to the regional and world economic and financial stability.
Before 1997, with steady appreciation of the RMB, market confidence on the Chinese currency substantially improved. However, in the wake of the Asian financial crisis, China as a responsible nation in the world voluntarily narrowed the RMB exchange rate band so as to prevent a worsening of the crisis which could be possibly fueled by competitive currency depreciation in the region. As the waves of the Asian financial crisis have gradually receded and due to the fact that China has sustained its steady and relatively fast growth over the recent years with economic system reform further deepened, restructuring of the commercial banks making fresh progresses, foreign exchange controls further slashed and the depth and breadth of the foreign exchange market further expanded, favorable conditions have been created for the reform of the RMB exchange rate regime.
2. Why do we need to reform the RMB exchange rate regime?
To reform the RMB exchange rate regime is a requirement for establishing and strengthening the socialist market economic system in China, it also represents an important component of the overall program to deepen the economic system reform and improve the macroeconomic adjustment mechanism. It is consistent with the requirements put forward by the central government regarding establishing a managed floating exchange rate regime based on market supply and demand and further improving the RMB exchange rate system so as to maintain the RMB exchange rate basically stable at an adaptive and equilibrium level. It also fits in with the fundamental and long-term interests of the country, reflects the objective requirement of implementing a scientific approach to economic development and holds great significance for promoting a comprehensive, coordinated and sustained development of the economy and society.
To reform the RMB exchange rate regime is also needed to ease external trade imbalance, boost domestic demand, strengthen competitiveness of the Chinese enterprises and upgrade the level of economic opening up. In recent years, a persistent expansion of the dual surpluses under both the current and capital accounts has worsened the balance of payments disequilibrium. At end of June 2005, China's foreign exchange reserves reached US$711 billion. Since the beginning of this year, China's trade surplus has continued to increase substantially, and trade frictions further intensified. A proper adjustment of the exchange rate and reform of the RMB exchange rate regime is beneficial to the implementation of the sustainable economic development strategy focused on domestic demand and to the improvement of resource allocation. It is also conducive to increasing the independence of monetary policy and enhancing the preemptiveness and effectiveness of financial macro-control. In addition, it is contributive to maintaining a broad balance and improving the terms of foreign trade; to preserving price stability and reducing cost for the enterprises; to transforming operational mechanisms of the enterprises so that they could strengthen innovation capacity and become more risk averse and competitive in the international market; and to optimizing utilization of foreign capital and improving economic opening up by taking full advantage of both the domestic and foreign resources and markets.
3. What are the goals and principles for the reform of the RMB exchange rate regime?
The goal of the RMB exchange rate regime reform is to establish a managed floating exchange rate regime based on market supply and demand and maintain the RMB exchange rate basically stable at an adaptive and equilibrium level.
The reform of the RMB exchange rate regime must be proceeded in a proactive, controllable and gradual way. "Proactive" means the reform mode, contents and timing must be based on the needs arising in the process of China's domestic reform and development. The impact of exchange rate regime reform on macroeconomic stability, economic growth and employment must be taken into account. "Controllable "implies that we must be able to control the movement of the RMB exchange rate on the macro level so that the reform momentum could progress steadily to avoid large fluctuations of the financial markets and the economy. "Gradual" means the reform of the exchange rate regime must be carried forward in a sequenced manner to ensure sufficient resilience of all the parties involved.
4. What are the contents and characteristics of the new RMB exchange rate regime?
After the reform, the RMB will no longer be pegged to the US dollar. Instead, the RMB exchange rate will be determined based on a basket of currencies selected in line with the real situation of China's external economic development. At the same time, proper measures could be taken to manage and adjust the RMB exchange rate based on market supply and demand and according to the domestic and international economic and financial developments with reference to the calculated exchange rate indices of the basket currencies, as an effort to maintain the RMB exchange rate basically stable at an adaptive and equilibrium level. Reference to a basket of currencies indicates that the RMB exchange rate could be affected by the exchange rate changes between the foreign currencies, but not necessarily a peg of RMB to the basket currencies. The managed floating exchange rate regime must also be based on another important factor which is the situation of market supply and demand.
RMB was slightly revalued by 2 percent before the RMB exchange rate was allowed to float with reference to a basket of currencies. Such an adjustment was actually determined considering the size of surplus and the needs in restructuring of China's foreign trade while at the same time taking into account the resilience of the domestic enterprises to absorb the risks.
5. Why did you move now to reform the RMB exchange rate regime?
The Chinese government has been consistent in pursuing an independent and highly responsible attitude towards the issue of the RMB exchange rate, and has since adopted the exchange rate regime and corresponding policies compatible with China's national conditions based on the country's fundamental interests as well as the social and economic developments. It is a relatively good time to reform the RMB exchange rate regime right now as the foreign exchange control has been gradually relaxed, with cultivation of the foreign exchange market further strengthened, more market instruments introduced to facilitate transactions and concrete progress achieved on financial reforms on various fronts; macroeconomic management has yielded manifest results with the economy continuing to grow in a steady and relatively fast manner; and the world economy has developed stably in conjunction with a solid appreciation of the US dollar. All these factors have created a favorable environment for the reform of the RMB exchange rate regime and laid a solid foundation to ensure its success.
6. How should the challenges brought by the reform of the RMB exchange rate regime be properly handled?
In the short term, the reform of the RMB exchange rate regime can have an impact on the economic growth and employment. But broadly speaking, the benefits of the reform outweigh the associated costs. We will push ahead the reform of the RMB exchange rate regime in a prudent way and create favorable conditions for and guide the enterprises to strengthen restructuring so as to transit smoothly throughout the reform period. Banking institutions and foreign exchange administration agencies should further improve financial services to provide strong support for the development of the enterprises. The enterprises should also accelerate restructuring and transform operational mechanisms in a bid to improve responsiveness to the reform of the exchange rate regime and to the movements of the exchange rates.
7. Do you expect large fluctuations of the RMB exchange rate after the reform?
The goal of the reform of the RMB exchange rate regime is to improve the exchange rate mechanism and maintain the RMB exchange rate basically stable at an adaptive and equilibrium level. Large fluctuations of the RMB exchange rate will exert heavy shocks to the economic and financial stability in China, thus do not fit in with China's fundamental interests. We will not tolerate such large fluctuations in the reform of the RMB exchange rate regime. First, after the reform, the RMB will no longer be pegged to a single currency, instead the RMB exchange rate will become adjustable based on market supply and demand with reference to exchange rate movements of currencies in a basket. The exchange rate changes of major currencies in the international market will objectively reduce volatility of the RMB exchange rate. Second, with a strengthened role of market instruments like the exchange rate in resource allocation, improved relationship between supply and demand of foreign exchange, and the enhancement of the stabilizing mechanism for the balance of payments, China's BOP position is likely to be kept in broad equilibrium, which will lay a solid economic foundation for the stability of the RMB exchange rate. Third, active measures will be taken to coordinate various macroeconomic policies and steadily push ahead reforms in different areas to create a favorable policy environment for the stability of the RMB exchange rate. Finally, the People's Bank of China will make unrelenting efforts to improve macroeconomic management and foreign exchange administration so as to faithfully fulfill its responsibility in maintaining the stability of the RMB exchange rate.
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Spokesman of the People's Bank of China on the Reform of the RMB Exchange Rate Regime