The Reform Of China And Its Currency Regime Economics Essay

In this essay we are traveling to analyze China ‘s exchange rate policy and Chinese fiscal and capital control reform of recent old ages, an epoch where exchange rate flexibleness is a cant, states are now floating off to flexible currency governments. In the 80s China has different exchange rate governments. However, in 1981 the double exchange rate system was introduced in China, the system was discontinued in 1985, during the constitution of Particular Economic Zones ( SEZ ) to hike the state ‘s export public presentation and the dual-exchange rate system was re-introduced in 1986.By 1994 China informed the International Monetary Fund ( IMF ) that they will be exchanging to a managed floating exchange rate system and this was the official policy for about 10 old ages. However, China has chosen to nail down its currency with the US dollar during all these old ages. In 2005 the state ended its old nog to the America dollar and let the Yuan to fluctuate over basket of currencies. ( Smith 2008 ) . China ‘s population is 1.3 billion, which represents one fifth of the universe ‘s population. With the huge population, and rapid turning economic system and China been considered as the emerging world power. China has the universe ‘s 3rd largest economic system and 2nd largest buying power para ( PPP ) .In international trade footings, China has the 3rd largest importer and 2nd exporter in the universe and its official currency is Yuan instead Renminbi ( RMB ) in Chinese.

The economic system of China is the 2nd largest in the universe after the USA with a GDP of $ 10.21 trillion in 2006 when calculated on buying power para ( PPP ) .China it ‘s the 4th largest in the universe after the USA, Japan and Germany, with nominal GDP of US $ 3.42 trillion in 2007 when measured in exchange rate. China has been the fastest turning state for the past one-fourth of a century with mean one-year GDP growing rate higher than 10 % . In 2007-2008, rising prices was approximately 7 % one-year footing lifting to 8.7 % in 2008 and foreign exchange modesty was $ 1.066 trillion in 2006 which have surpassed Japan, doing China ‘s foreign exchange militias the largest in the universe. ( Roubini 2007 ) .The essay will give a brief point of view on China and its economic system, most particularly on its pecuniary policy.

During 1950s and 1960s China ‘s exchange rate policy was controlled by the state ‘s geo-political, security, strategic involvements, and economic computations played small in the exchange rate finding. Nevertheless, in January 1970, China ‘s currency reform, substituted 10,000 renminpiao for one renminbi ( RMB ) besides called kwai and the value was fixed at an official rate of 2.46 kwais to America dollar. After the autumn of Bretton Wood government of fixed rates based on dollar to dollar was been linked to gold, force per unit area started for RMB reappraisal and its official rate was set at 2.26 kwais to a dollar, in 1971. As at the clip dollar started deprecating quickly the Chinese pecuniary governments had to bind the Yuan to the Hong Kong and the British lbs sterling. Furthermore, the free natation of Hong Kong dollar and its rapid decrease made Chinese pecuniary governments to function the nexus between Hong Kong dollar and RMB in 1974, the successful rate of Yuan was pegged to a trade -weight basket of 15 currencies, though the currencies in the basket was non been identified. ( Soofi, 2009 ) .

Centrally Controlled Exchange Rate System in China: 1949-1979

Harmonizing to ( Zhang,1999 ) before 1979 China exchange rate system was centrally planned, the cardinal authorities had the power to make up one’s mind the value of currency. However, the exchange rate government merely served as a cardinal accounting tool. Under the exchange rate system, few state- owned endeavors could subscribe import and export contracts. The exchange rate system did non impact the current history balance, because the cardinal authorities decides on export and import. Furthermore if domestic importers need to import goods, foremost the goods have to be approved by the authorities and so purchase foreign exchange utilizing official exchange rate from the authorities. After importing the goods if the bargainers make any loss in international minutess the cardinal authorities would subsidize this bargainers. Under the exchange rate government, domestic exporters and importers did n’t hold any inducements to take advantage of because they could non maintain the net income of what they earn, on the other these domestic bargainers ne’er suffered any losingss. In 1979-1985 the double exchange rate system, Yuan started to reform from a centralised control system which the exchange rate was been decided by the market forces of supply and demand. However, it was done to convey down the value of Yuan in order to promote exports. In 1979 Chinese authorities established SAFE State Administration of Foreign Exchange in order to command foreign exchange market. At the same clip, keeping system was been introduced to advance the public presentation of export, domestic exporters now have to maintain some net incomes, and give the remainder to the cardinal authorities. By 1981, the double exchange rate system was introduced to heighten export public presentation, an official rate for non-trade dealing and ( ISR ) internal colony rate for authorised current history dealing, the rates were been fixed by the cardinal authorities. Yuan started to devaluate, importers did n’t confront much trouble from the devaluation as Yuan gave them high net incomes. As exporter made more net income instead than the old system which they benefited from internal colony rate ( ISR ) which was far lower than the official rate. Banks were confused which the rate to use, official rate or ISR? In 1985, the authorities erase the ISR, which was besides the terminal of the double exchange rate system. ( Smith, 2008 ) .

Swap Exchange Rate Market: 1986-1993

During 1980 onwards the authorities built Particular Economic Zones ( SEZ ‘s ) in the costal area.The Special economic zones attracted many FDI ( Smith, 2008 ) . Experiencing rapid growing, these houses needed a batch of foreign exchange, as at 1986 the Chinese authorities established ( FEAC ) Foreign Exchange Adjustment Centres, which was besides called the barter Centres. The double exchange rate system emerged once more in PRC, foremost was the swap exchange rate and the other was the official exchange rate. ( Lin, 2003 ) describe that companies can offer and inquire in the barter Centre, been the first clip in China that the exchange rate was been determined by the forces of market demand and supply. This barter Centre was wholly different from other developed states. It ‘s a topographic point where foreign fund concerns and domestic houses sell their retained foreign exchange for domestic currency. ( Zhang, 2001 ) describe that because the official exchange rate was been fixed as at that period, the fluctuating barter market exchange rate became successful exchange rate. The authorities besides adopted some policies to spread out the reform of the exchange rate, so that bargainers could derive a higher part of keeping and the monetary value was been liberalised. Although ( Zhang, 2001 ) said that barter market exchange rate system was volatile because big FTC gathered many keeping quotas. This immense sum of quotas, in and out of the barter market resulted in immense fluctuation which could be a serious job and this job clearly stated the demand for fusion in different exchange rates.

Fusion of the Exchange Rate – dollar peg 1994-2005.

After China uniformed their exchange rate in 1994, the cardinal authorities began to follow a managed floating exchange rate with a narrow set ( Wang and Huang 2004 ) .During 1994, the RMB was equalled to 8.7 Yuan per 1 USD and the value could be adjusted to 0.25 % of its old market exchange, from 1995, the RMB started to appreciate, in 1995, it was 8.3 % USD.Although the Chinese authorities announced to the IMF to hold a managed floating exchange rate system from 1994, the exchange rate was been pegged with dollar since 1994. Since 1994 to July 2005, the policy on currency was been pegged informally and the value of Yuan against the America dollar, this policy was praised during the fiscal crisis in Asia in 1998 which prevented a unit of ammunition of competitory devaluation.

In July 2005, China announced a switch in its exchange rate government whereby its currency, was successfully pegged to the America dollar, would alternatively be pegged to a basket of foreign currencies. Eleven currencies consisting this basket were shown, viz. U.S. dollar, euro, South Korean won, Malayan ringitt, Singapore dollar and Nipponese hankerings, with a smaller proportion made up of the British lb sterling, Russian ruble and Thai tical. However their weighting and the frequence which these weights might be altered were non been disclosed. China besides announced that the Yuan would merchandise within a narrow 0.3 % set against the basket. As such, the Yuan may fluctuate 0.3 % above or below the old twenty-four hours ‘s shutting exchange rate, but the value will be determined by mentioning to a basket of currencies, non merely the dollar merely. ( Zhang, 2000 )

Harmonizing to ( Zhang, 2000 ) claims that China ‘s export led growing policy affected China ‘s assortment of exchange rate system. Since the PRC, started to reform its exchange rate system, the authorities used a existent mark attack.

Corden ( 2001 ) describe that the state used this attack to make external and internal balance. Zhang ( 2000 ) explain that the ISR exchange rate, swap market exchange rate and interbank exchange rate all expressed the authorities existent aim to hike the export public presentation of companies. The exchange rate was targeted at the cost of gaining a unit of foreign exchange through exporting.

Morrison ( 2005 ) is sentiment was that maintaining the Chinese currency pegged to the America dollar reduces the uncertainness and hazard in the international trade and fiscal markets and to some extent, it increased the trade public presentation between China and United States. This can be illustrated below ;

1991-2003 China ‘s existent exchange rate against U.S and its bilateral export: 1991-2003

Beginning: World Development Indicator and Direction of trade Statisticss 2004.

The figure above shows the existent exchange rate of RMB ( Chinese Currency ) against the America and the bilateral export from China to the United States of America. As we can see the devaluation in 1997 led to dramatic addition in exports to the America.

However, nail downing to the US dollar triggered increased exports between China and Japan and this can be illustrated below:

1991-2003: China ‘s trade with Japan and U.S.

Beginning: International Financial Statistics 2004.

However, the ground why China pegged its currency to the USD alternatively of the Yen, was because most of the international trade were invoiced in US dollar ( McKinnon ; 2000 ) .

Sato ( 1998 ) claimed that the chief ground why Nipponese Hankering was non been used as the invoiced currency for international trade was because of the comparatively developing fiscal markets.

Robert Mundell, a Nobel Prize victor in economic sciences, is one among the individuals who levelled greatest unfavorable judgment against the bead of the dollar nog.

Mundell besides argued that any alteration by China whether a one off reappraisal of the exchange rate or a displacement to a natation rate would non be in China ‘s ain involvements, and in fact have small consequence on the root causes of US dissatisfaction. He explains that the displacement in the currency government would convey harm in volatility to China, thereby harming employment and growing in the domestic economic system.

China as a currency operator

Critics of China ‘s currency government point to three factors as grounds that the Chinese authorities is pull stringsing its currency:

Its high and lifting bilateral trade excess with the United States

two ) Its high and lifting planetary current history excess

( three ) Its high and lifting international militias accretion.

These critics contend that the RMB is undervalued, comparative to the U.S. Dollar by between 15 and 40 % , or an norm of 27.5 % . Undervaluation operates as a subsidy by the Chinese authorities to Chinese companies by doing Chinese merchandises less expensive in U.S. and foreign markets. As a consequence, the United States trade shortage with China has widened and 10s of 1000s of America occupations, chiefly in the fabrication sector, have disappeared. The U.S. authorities have to coerce PRC to follow a more flexible exchange rate policy even a free drifting exchange rate policy and to punish China for past and current currency use.


On the positive side, China has a bright hereafter in front, particularly in footings of economic prosperity. The pick of its currency government has so boosted China ‘s fight in the planetary universe. Apart from being a low-priced leader in the planetary market, the currency regime consist of a managed float, be it dollar or basket nog, has helped China to invoice cheaper than the United State, the universe ‘s premier exporter. Furthermore, under the existent currency government, although there are multiple grounds to progress for this displacement, it has been political force per unit area that has catalysed the affair. Dollar still has a major per centum in the currency basket. Besides, an undervalued Yuan is conveying so much prosperity to China, So, rationally any state would wish to maintain the system while a free float system would convey the Yuan to an equilibrium, that is about 30 % higher ( Frankel, 2005 ) and could cut down exports.