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Continuing reform of the RMB exchange rate formation mechanism
Latest Updated by 2006-08-17 08:26:24
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China's reform of the RMB exchange rate mechanism has been successful in its first year. However, this is only the first step on a "Long March". As one of the important systems in improving the structure of the socialist market economy, the RMB exchange rate mechanism must be further improved and natural market forces must be allowed to play a greater role in the formation of the exchange rate.

On August 9, the People's Bank of China issued an Appendix to the Report on Implementation of Monetary Policy, which summarized reforms made to the RMB exchange rate over the past year. Last year began with a surprising reform to the existing operation ¨C which was considered to be functioning well -- and now the RMB exchange rate reforms have achieved the expected results.

The aims of the reforms have been achieved; the exchange rate is increasingly allowed to fluctuate more naturally according the ups and downs of the market. In terms of the flexibility of the exchange rate, from July 21 of last year to the end of this July, the rate of exchange of the RMB against the US dollar has fluctuated both ways. The highest rate was 7.9732 yuan and the lowest 8.1128. The cumulative appreciation rate reached 3.8 per cent. The floating flexibility of the RMB exchange rate increased.

To deal with foreign exchange market construction and actual supply and demand pressures, China set up a preliminary foreign exchange market system composed of a counter-retail market and an inter-bank wholesale market in 2005. The foreign exchange market, with multiple transactions co-existing within the system, covers transactions of various fundamental foreign exchange products such as spot, forward and swap. All of these have enhanced the strength of the market in determining the exchange rate. China has also liberalized foreign-exchange management in well-ordered steps and gradually eased restraints on actual supply and demand, which has created a favorable policy environment for bringing the market to full play in forming exchange rates.

Although people raised concerns at the time of reform, none of their anticipated problems have materialized. In fact, the fallout of the new exchange rate formation mechanism is limited in both the macro and micro economy. People did not anticipate the appreciation of the RMB, or that so much money would pour into the country.

Of course, this is the first year of exchange rate reforms and is only the first step on the "Long March". As one of the important systems needed to improve the structure of the socialist market economy, the RMB exchange rate mechanism requires further improvements and must be allowed to fluctuate more freely according to the market.

For its next step, China should further exploit the basic function of market supply and demand to determine the exchange rate and gradually improve the flexibility of the RMB exchange rate. By doing this they will maintain a stable RMB exchange rate at a reasonable and balanced level.

Efforts should be made to promote the development of foreign exchange markets; they should encourage financial institutions to be more innovative so as to provide enterprises and residents with more diverse hedging tools. Meanwhile, China should further relax restraints on the foreign exchange administration so that residents can purchase and use foreign exchange more easily. This should clarify the relationship between foreign exchange supply and demand and truly accomplish the goal of "storing the reserves with the people".

Furthermore, in the process of allowing market trends to have a greater impact on the formation of the exchange rate, the market should be guided to form accurate exchange rate expectations. To resolve the current imbalance of payments, consumption must be expanded, savings rates lowered, imports increased, preferential policies for foreign investment adjusted, and exchange rate flexibility improved. The exchange rate will exert a certain influence on these processes, but the appreciation of the exchange rate should not be solely relied upon to realize the BOP (balance of payments). Nor should the exchange rate of the RMB against US dollars be the primary focus; the exchange rate of the RMB against the currencies of other major trading partners should also be considered, and not only should the nominal exchange rate be consulted, but it should be compared to actual exchange rates after deducting price factors. Even if the nominal exchange rate remains unchanged, the growing price of land, labor and energy will cause the real exchange rate to appreciate, a key factor in influencing international competitiveness of enterprises and macroeconomic operations.

Editor: Yan

By: Source: People's Daily website
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