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What will be the trend of the Yuan exchange rate?
Latest Updated by 2007-05-23 15:43:05
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In the five trading days following the "May 1st" holiday, the Yuan's exchange rate broke three barriers: on May 8th, the mid-point rate against the US dollar rose above 7.70 for the first time, then went beyond 7.69 on May 11th, and broke 7.68 on May 14th to hit a new height of 7.6739, being the 29th time the rate replaces a record in this year.

China introduced exchange rate reform on July 21, 2005, dropping the decades-old peg to the US dollar and linking the Yuan to a basket of other currencies. Since then, the flexibility of the Yuan's exchange rate has been continuously enhanced with a general trend of gradual increase.

The slight rise in the rate is chiefly a result of a relatively large surplus in the balance of payments and an over supply in foreign exchange market. The surplus has been rising in recent years as trade surplus and foreign investment are growing rapidly and foreign currencies have flowed in, naturally pushing the RMB exchange rate higher and higher.

Last March, the trade surplus, which had remained high, saw a drop to 6.87 billion US dollars, a reduction of 16.89 billion dollars over the previous month. Accordingly, the Yuan's exchange rate rose only 130 points that month, significantly less than the 297 points and 206 points in January and February. In April, the trade surplus rebounded to 16.9 billion dollars, more than twice of the March figure, and the rate therefore increased by 251 points, and continued to escalate after "May 1st".

The influx of foreign funds has greatly replenished the domestic market, has increased banking fluidity and made monetary policy regulations more difficult. While affecting long term, stable prices of commodities, this influx also has thrust funds into the manufacturing sector and areas such as stock and real estate, giving rise to a rebound in fixed asset investments, causing assets to bubble. To achieve a balance of payments and sound, fast economic development, a package of policies including the exchange rate must be established. The adjustment of the Yuan's exchange rate, as a form of price leverage and an "invisible hand", plays a specific role in regulating the balance of payments.

Then what will be the trend of the Yuan's exchange rate?

The relatively large surplus in the balance of payments will exist for a period of time if certain domestic and international conditions remain constant:

--Trade surplus will remain large. In recent years, investment has been growing rapidly, but resident deposits have been growing faster. Meanwhile, investment on fixed assets has led to a swelling manufacturing capability, which cannot be "assimilated" completely in the domestic arena and has to be dealt with by expanding exports.

--International capital must keep flooding in. The service sector will be a key area to open up. Financial insurance, telecommunications, logistics and other modern service sectors will bring in a flow of bumper capital, and companies listed overseas will also add to the influx of capital.

--Outgoing investment can strongly divert surplus. Outgoing capital is an important channel with which to balance payments. In 2005, Japan's surplus was as high as 165.8 billion dollars, but due to an outflow of 127.6 billion dollars of investment capital, the general surplus of domestic payments was only 38.2 billion dollars. Under current market conditions, however, China's outgoing investments in resources, energy, manufacturing, and finance need time to develop.

On May 18th, the central bank in China announced that the country will widen the floating band of the Yuan against the US dollar for daily spot trading on the inter-bank market from 0.3 percent to 0.5 percent as of May 21st, in another effort to increase the flexibility of the Yuan's exchange rate.

It must be noted that the imbalance of payments, should be re-examined from many angles, according to expanding domestic (especially consumer) demands, changing economic growth modes, and the adjustment of foreign trade administration, foreign investment and foreign exchange, as well as the exchange rate, instead of solely relying on a large hike in the exchange rate.

On the other hand, when increasing the flexibility of the Yuan's exchange rate, we must consider its impact on macroeconomic stability, economic growth and employment; on the financial system and enterprise; as well as on the economy of neighboring countries, regions and the world. Therefore, we cannot allow major fluctuations in the rate, but must keep it stable at a reasonable and balanced level.

Editor: Yan

By: Source: People's Daily website
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