Contents Chinese financial markets International Monetary System and the Part 4: the Foreign Exchange Markets and rmb internationalization Purchasing Power Parity and Interest Parity History of RMB Exchange Rate Reform Foreign Exchange Markets, RMB Offshore Sept. Dec 2016 Market and RMB Internationalization By Zhang Xiaorong Currency Terminology 4.1 International Monetary System Foreign Currency Exchange Rate the price of one country s currency in units of another nd the"Impossible Triangle Spot Exchange Rate to be delivered at nce, or in two business days for interbank transacti Exchange Rate Regime he rules and arrangements on how and how much the exchange rate can change Currency Terminology International Monetary System Devaluation of a Currency In simple words, the international monetary system efers to a drop in foreign exchange value of a currency is composed of the rules and procedures for The opposite is revaluation More academically, the international monetary Weakening, deterioration, or depreciation of a ystem is the structure within which foreign Currency exchange rates are determined, international trade refers to a drop in the foreign exchange value of a floating and capital flows are accommodated and the balance-of-payments adjustments made The opposite is strengthening or appreciation
2016/11/2 1 Chinese Financial Markets Part 4: the Foreign Exchange Markets and RMB Internationalization Sept.-Dec.2016 By Zhang Xiaorong Fudan University, Shanghai, China 4-1 Contents • International Monetary System and the “Impossible Triangle” • Purchasing Power Parity and Interest Parity • History of RMB Exchange Rate Reform • Foreign Exchange Markets, RMB Offshore Market and RMB Internationalization 4-2 4.1 International Monetary System and the “Impossible Triangle” 4-3 Currency Terminology • Foreign Currency Exchange Rate – the price of one country’s currency in units of another currency. • Spot Exchange Rate – the quoted price for foreign exchange to be delivered at once, or in two business days for interbank transactions. • Exchange Rate Regime – the rules and arrangements on how and how much the exchange rate can change – Can be fixed (pegged) or floating (flexible) 4-4 Currency Terminology • Devaluation of a Currency – refers to a drop in foreign exchange value of a currency that is pegged to gold or another currency. – The opposite is revaluation • Weakening, deterioration, or depreciation of a Currency – refers to a drop in the foreign exchange value of a floating currency. – The opposite is strengthening or appreciation 4-5 International Monetary System • In simple words, the international monetary system is composed of the rules and procedures for exchanging national currencies. • More academically, the international monetary system is the structure within which foreign exchange rates are determined, international trade and capital flows are accommodated, and the balance-of-payments adjustments made. 4-6
Hist ry International Monetary System International Monetary System Gold Standard (1876-1913) WWl and Wwll Years(1914-1944) Rules of the ga each country set the rate at which it urgencies were allowed to fluctuate over a fairly wide urgency unit could be converted range in terms of gold and each other. in effect faxes. the ratio or par values or currences, were Increasing fluctuations in currency values became realized due to speculation and hurt the international trade. Expansionary monetary po governments supply of gold The US adopted a modified gold standard in 1934 Was in effect until the outbreak of wwi as the free movement of gold was interrupted he only major trading currency that continued to be convertible History of Bretton Woods Agreement International Monetary System WWI and WWll Years Bretton Woods Agreement(1944-1973) Us dollar based international monetary system established: nflation!!I fixed price between US dollar and gold: fixed price between the International Monetary Fund(IMF)and the World Bank Helps countries defend their currencies against cyclical, seasonal, or random occurrences Assist countries having structural trade problems if they promise to take adequate steps to correct these problems After Bretton Woods Agreement Bretton Woods Agreement Worked pretty well during the post-wWll era of reconstruction An Eclectic Currency Arrangement(1973- and growth in world trade ch 1973, exchange rates have becom ore volatile and less predictable than they inflation and various currency shocks among countries the"fixed flation(oil crisis, vietnam War) in US transferred to other There have nificant world countnes for example, the birth of Triffin dilemma for a reserve currency: requiring trade deficit but too much debt would lead to confidence crisis occurred Dollar is challenged by not only euro but also emerging After efforts of US suspend official purchases or sales of gold by the US Treasury on August 15, 197 Most currencies started to float from march. 1973
2016/11/2 2 History of International Monetary System • Gold Standard (1876-1913) – “Rules of the game” : each country set the rate at which its currency unit could be converted to a weight of gold – Exchange rates, the ratio of par values of currencies, were in effect “fixed” – Expansionary monetary policy was limited to a government’s supply of gold – Was in effect until the outbreak of WWI as the free movement of gold was interrupted 4-7 History of International Monetary System • WWI and WWII Years (1914-1944) – Currencies were allowed to fluctuate over a fairly wide range in terms of gold and each other. – Increasing fluctuations in currency values became realized due to speculation and hurt the international trade. – The US adopted a modified gold standard in 1934. – During WWII and its chaotic aftermath the US dollar was the only major trading currency that continued to be convertible. 4-8 History of International Monetary System • WWI and WWII Years (1914-1944) – Inflation! – Hyper-inflation!!! 4-9 Bretton Woods Agreement • Bretton Woods Agreement (1944-1973) – US and UK representatives met in 1944 at Bretton Woods, New Hampshire to create a post-war international monetary system – a US dollar based international monetary system established: fixed price between US dollar and gold; fixed price between other currencies and US dollar – the International Monetary Fund (IMF) and the World Bank • IMF – Helps countries defend their currencies against cyclical, seasonal, or random occurrences – Assist countries having structural trade problems if they promise to take adequate steps to correct these problems 4-10 Bretton Woods Agreement • Worked pretty well during the post-WWII era of reconstruction and growth in world trade • experienced inconsistency of monetary and fiscal policies, inflation and various currency shocks among countries • Inflation (oil crisis, Vietnam War) in US transferred to other countries • Triffin dilemma for a reserve currency: requiring trade deficit , but too much debt would lead to confidence crisis occurred • After efforts of US suspend official purchases or sales of gold by the US Treasury on August 15, 1971 • Most currencies started to float from March, 1973 4-11 After Bretton Woods Agreement • An Eclectic Currency Arrangement (1973 – present) – Since March 1973, exchange rates have become much more volatile and less predictable than they were during the “fixed” period – There have been numerous, significant world currency events over the past 30 years, for example, the birth of euro, financial crises in Latin America and Asia. – Dollar is challenged by not only euro but also emerging market currencies. 4-12
After After Bretton Woods Agreement Bretton Woods Agreement Exchange Rate Regime Exchange Rate Regime Classification in IME Classification in IMF (2014) de jure classification(1975-1998 IMF judges the regime based on the stated commitment of de facto classification(since 1999) their de facto policies after asian Crisis information on each country's 1 eserves and official and secondary market rates floating 39 Choice of Exchange Rate regime The Impossible Trinity A nation s choice as to which currency regime to follow The forces of international economics do not alloy eflects national priorities about all facets of the the simultaneous achievement of all three conomy, including inflation, unemployment, interest rate levels, trade balances, and economic growth The choice between fixed and flexible rates may change over time as priorities change. However, increasing capital mobility complicates the hoices after 1970s Any currency will encounter the"impossible trinity Pure floating ntegration
2016/11/2 3 After Bretton Woods Agreement 4-13 After Bretton Woods Agreement 4-14 Exchange Rate Regime Classification in IMF • de jure classification (1975-1998) – IMF judges the regime based on the stated commitment of the central bank; • de facto classification (since 1999) – IMF began to characterize countries’ regimes based on their de facto policies after Asian Crisis – Available information on each country’s exchange rate and monetary policy framework; observed movements on reserves and official and secondary market rates; quantitative and qualitative analysis 4-15 Exchange Rate Regime Classification in IMF (2014) 16 Number of Countries and Regions Examples No separate Legal Tender 13 Ecuador, San Marino Currency Board 12 HK SAR, Bulgaria, Lithuania Conventiona Peg 44 Aruba, Jordan Stabilized arrangement 21 Guyana, FYR Macedonia, Singapore, Vietnam Crawling peg 2 Nicaragua, Botswana Crawl-like arrangement 15 Honduras, Ethiopia, China, Argentina Pegged echange rate within horizontal bands 1 Tonga Other arrangements 18 Cambodia, Czech Rep., Russia, Costa Rica Floating 36 Afghanistan, Brazil, Korea, Thailand, New Zealand Free floating 39 US, Australia, Canada, Chile, Japan, Mexico, Norway, Poland, Sweden, UK, Somalia, EMU Choice of Exchange Rate Regime • A nation’s choice as to which currency regime to follow reflects national priorities about all facets of the economy, including inflation, unemployment, interest rate levels, trade balances, and economic growth. • The choice between fixed and flexible rates may change over time as priorities change. • However, increasing capital mobility complicates the choices after 1970s. • Any currency will encounter the “impossible trinity” problem. 4-17 The Impossible Trinity • The forces of international economics do not allow the simultaneous achievement of all three 4-18 Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility
The Impossible Trinity The Impossible Trinity Where are the Us, Euro countries and china? Where will China be? Erchange rate stabilin What is the cost and benefit of the gradual path in reforming RMB? Why Determines the Exchange Rate? A somewhat popular argument xchange rate stable 4.2: Purchasing Power Parity and Interest Rate Parity but every country can do so More fundamentally Issue more RMB- inflation Try to buy the whole world >sell RMB) depreciation Stabilize exchange rate thorough FX cont nflation currency depreciation Why Determines the Exchange Rate? Why Determines the Exchange Rate? Another popular argument Our major purposes for holding a foreign currency If we raise interest rate and attract more foreign capital our currency will appreciate. consumption: to buy products from that counts\,to An intuitive refutation but then you have to keep them in our country and Parity conditions Purchasing Power Parity: Price levels(inflation rates) More fundamentally affect exchange rat Raising interest rate is costly for the domestic economy Interest Rate Parity: rates of return on financial assets acts hot money and brings instability in the affect exchange rate Deviation on one variable will be FDI capital looks for better investment environment ther if there is no limit to arb 4
2016/11/2 4 The Impossible Trinity 4-19 Where are the US, Euro countries and China? Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility The Impossible Trinity 4-20 Where will China be? Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility • If pure floating is the only direction that China will go, why don’t we jump to it over one night? • What is the cost and benefit of the gradual path in reforming RMB? 4.2: Purchasing Power Parity and Interest Rate Parity 4-21 Why Determines the Exchange Rate? • A somewhat popular argument – If we issue RMB as much as possible and keep RMB exchange rate stable, we can buy the whole world! • An intuitive refutation – but every country can do so! • More fundamentally – Issue more RMB inflation – Try to buy the whole world sell RMB depreciation – Stabilize exchange rate thorough FX control?Then you have no way of buying the world • Inflation currency depreciation 4-22 Why Determines the Exchange Rate? • Another popular argument – If we raise interest rate and attract more foreign capital, our currency will appreciate. • An intuitive refutation – but then you have to keep them in our country and never let them go back • More fundamentally – Raising interest rate is costly for the domestic economy – It attracts hot money and brings instability in the FX market – FDI capital looks for better investment environment 4-23 Why Determines the Exchange Rate? • Our major purposes for holding a foreign currency – Consumption: to buy products from that country – Investment: to invest in that country (FDI or portfolio investment) • Parity conditions – Purchasing Power Parity: Price levels (inflation rates) affect exchange rate – Interest Rate Parity: rates of return on financial assets affect exchange rate – Deviation on one variable will be compensated by the other if there is no limit to arbitrage 4-24
2016/11/2 Commodity price and Exchange Rates Purchasing Power Parity Law of one price Absolute ppp does not hold If the identical product or service can be sold in Transportation costs, which depend on geography and different markets, and no restrictions exist on the sale or chnology nsportation costs of moving the product between Tariffs non-tariff trade barriers arkets arbitrage would soon equalize the products price Other border frictions in the markets Purchasing Power Parity ue for all goods and services, the purchasing er parity (ppp) exchange rate could be found from any individual set of prices. A simple conversion from US dollar price ps to RMB price But it tells how much international goods market is integrate P gives PsxS=P" and where competitiveness of multinational firms lie at. The PPP Exchange Rate The Real Exchange Rate PPP exchange rate is the rate implied by the commodity prices Implication for a country's export It gives an estimate of what rate would make the same basket A made-in-China product, priced in RMB as Y300, given of goods and services cost the same in two different countrie the nominal x/s rate 0. 15, the s price should be $45. If rising labor costs in China lead Y price rising to 350, at is about 4.5 Price of Chinese goods to Americans rises by 16.67%]loss While the nominal rate is 6.6 of competitiveness in the global product market Therefore, RMB is undervalued according to its purchasing real terms, the us dollar has fallen in value(depreciated) power. lative to RMB; or, RMB appreciates against uS dollar in screpancy The Real Exchange Rate PPP and Currency Under- or Over-Valuation 3 options to gain back the competitivene Another perspective of PPp ncies often need to be evaluated 2. keep s price unchanged, accept thinner profit margin gainst other currency values to determine relativ 3. Use the nominal rate as a weapo preciation of RMB from 0.15 to 0.1286 offsets the 50×0.1286=545 The objective is to discover whether ons exchang Real exchange rate rate is " overvalued or*undervalued"in terms of Ppp RER=S"P*/PS: let s suppose US-made products sell at S50 Before depreciation: RER=S'P/Ps =0. 15300/50=0.9 Examples: BigMac Index, Starbucks Index, GDP After depreciation: RER=S*P/P5=0.1286*350/50=0.9 adjusted Big Mac Index
2016/11/2 5 Commodity Prices and Exchange Rates • Law of One Price – If the identical product or service can be sold in two different markets, and no restrictions exist on the sale or transportation costs of moving the product between markets, arbitrage would soon equalize the products price in the markets. • Purchasing Power Parity – If LOP were true for all goods and services, the purchasing power parity (PPP) exchange rate could be found from any individual set of prices. – A simple conversion from US dollar price P$ to RMB price P¥ gives P$ x S = P¥ 4-25 Purchasing Power Parity • Absolute PPP does not hold well because there are barriers – Transportation costs, which depend on geography and technology – Tariffs & non-tariff trade barriers – Other border frictions • But it tells how much international goods market is integrated and where competitiveness of multinational firms lie at. 4-26 The PPP Exchange Rate • PPP exchange rate is the rate implied by the commodity prices in the two countries. • It gives an estimate of what rate would make the same basket of goods and services cost the same in two different countries. • Example – the IMF’s current estimate of the PPP exchange rate for RMB is about 4.5 – While the nominal rate is 6.6 – Therefore, RMB is undervalued according to its purchasing power. – Implication: Firms or individuals should in general sell products in $ and buy in ¥ (don’t forget the discrepancy among products!) 4-27 The Real Exchange Rate • Implication for a country’s exporting – A made-in-China product, priced in RMB as ¥300, given the nominal ¥/$ rate 0.15, the $ price should be $45. – If rising labor costs in China lead ¥ price rising to 350, at the unchanged nominal rate, the $ price is $52.50. – Price of Chinese goods to Americans rises by 16.67%loss of competitiveness in the global product market! – In real terms, the US dollar has fallen in value (depreciated) relative to RMB; or, RMB appreciates against US dollar in real terms. 4-28 The Real Exchange Rate • 3 options to gain back the competitiveness: 1. cut cost: and how? 2. keep $ price unchanged accept thinner profit margin 3. Use the nominal rate as a weapon: An depreciation of RMB from 0.15 to 0.1286 offsets the effect. (350×0.1286= $45.) • Real exchange rate • RER=S*P¥ /P$ ; let’s suppose US-made products sell at $50 • Before depreciation: RER=S*P¥ /P$ =0.15*300/50=0.9 • After depreciation: RER=S*P¥ /P$ =0.1286*350/50=0.9 4-29 PPP and Currency Under- or Over-Valuation • Another perspective of PPP – Individual national currencies often need to be evaluated against other currency values to determine relative purchasing power. – The objective is to discover whether a nation’s exchange rate is “overvalued” or “undervalued” in terms of PPP. • Examples: BigMac Index, Starbucks Index, GDPadjusted BigMac Index 4-30
2016/11/2 Big Mac Index 2014-Undervaluation Big Mac Index 2014-Undervaluation sPrice at Img Market Over/Under Price at Local 5 Pric Implied Market over/Under States SFr 6.5 HKS 16 2.12393 Rea10.25 244367 Africa Rand 19.9 2.45 1.14 4.644.774.31 NTS 75 4.63214419.45 经 CBN Cost of Living Index CBN Cost of Living Index Eg China Business News released the ppp exchange rate and undervaluation of RMb on july 21st 2010. …2# commodity for more than 50 economies, CBN focuses on RMB 1m“ by comparing the prices of 30 daily-living items in Shanghai with those in New York, London, Paris and Tokyo. The 30 chosen items reflect the cost of modern living in the cities, covering 6 categories including clothing, food lodging transportation, service and other. ot surprising--RMB is undervalued by 28%, 43%, 35% and 42% respectively CBN Cost of Living Index From appp to RPPp Relative purchasing power parity ange in the differential rate of inflation between two 日2三 ountries tends to be offset over the long run by an eq t opposite change in the exchange rate between the two :灬 oes RPpP hold? ": In the short run no. trade flows are much slower to ue aman sponse to return differentials. The slow response in the product market provides MNEs time and space to arbitrage on raw materials and products all over the world and make a profit
2016/11/2 6 Big Mac Index 2014- Undervaluation Price at Local Currency $ Price at Market Rate Implied PPP Market Rate Over/UnderValuation(%) United States $4.20 4.20 - - - Norway Kroner 41 6.79 9.77 6.04 62 Switzerland SFr 6.5 6.81 1.55 0.96 62 Sweden SKr 41 5.91 9.77 6.93 41 Brazil Real 10.25 5.68 2.44 1.81 35 Denmark DK 31.5 5.37 7.50 5.86 28 Australia A$4.80 4.94 1.14 0.97 18 Argentina Peso 20.0 4.64 4.77 4.31 10 Canada C$4.73 4.63 1.13 1.02 10 Uruguay Peso90 4.63 21.44 19.45 10 4-31 Big Mac Index 2014- Undervaluation Price at Local Currency $ Price at Market Rate Implied PPP Market Rate Over/UnderValuation(%) United States $4.20 4.2 - - - India Rupee 84.0 1.62 20.01 51.9 -61 Ukraine Hryvnia 17 2.11 4.05 8.04 -50 Hong Kong HK$ 16.5 2.12 3.93 7.77 -49 Malaysia Ringgit 7.35 2.34 1.75 3.14 -44 China Yuan 15.4 2.44 3.67 6.32 -42 South Africa Rand 19.95 2.45 4.75 8.13 -42 Indonesia Rupiah 22,534 2.46 5369 9160 -41 Thailand Baht 78 2.46 18.58 31.8 -41 Taiwan NT$ 75.0 2.5 17.87 30 -40 Egypt Pound 15.5 2.57 3.69 6.04 -39 4-32 CBN Cost of Living Index • China Business News released the PPP exchange rate and undervaluation of RMB on July 21st 2010. • Rather than providing the comparison based on one commodity for more than 50 economies, CBN focuses on RMB by comparing the prices of 30 daily-living items in Shanghai with those in New York, London, Paris and Tokyo. • The 30 chosen items reflect the cost of modern living in the cities, covering 6 categories including clothing, food, lodging, transportation, service and other. • The results are not surprising——RMB is undervalued by 28%, 43%, 35% and 42% respectively. 4-33 CBN Cost of Living Index 4-34 CBN Cost of Living Index 4-35 4-36 From APPP to RPPP • Relative purchasing power parity – any change in the differential rate of inflation between two countries tends to be offset over the long run by an equal but opposite change in the exchange rate between the two countries. • Does RPPP hold? – In the short run, no. Trade flows are much slower to respond to price differentials than capital markets response to return differentials. – The slow response in the product market provides MNEs time and space to arbitrage on raw materials and products all over the world and make a profit
2016/11/2 Interest Rates and Exchange Rates Covered Interest Parity If Janet Yellen hints the fed will raise s interest rate, how will Investor has USD 10 S/E Spot RMB respond in the foreign exchange market? million to put on deposit S/E 360 day forward In the capital market, investors arbitrage on interest rates G0-day Libor rying to finance with currencies of low interest and invest in pot, put proceeds d ∈360- day libor 4.3% emember this may be prohibited by the capital control. sell balance forward for Even if not, investors may also encounter exchange rate changes, which may eat all the arbitrage profit. They need to cover(hedge) the profit in the forward market. Covered Interest Parity Covered Interest Arbitrage(CIA) Eurodollar rate 400% per anau will have $10*(1+4)=510, 4 million in 360 days Invest on毛 exchange s to e at the spot rate get 66 4516 million will have E6 7290 million in 360 days(=6.4516x1043). emro meT maker s104165 million(=67290×1.548) The better choice is investing in E an also borrow in s and investing in interest rat arbitrage Covered Interest Parity Forward rate and and Forward rate Interest Rate Parity risk free arbitrage terest Rate Parity(IRP) he difference in the national interest rates for securities of Spot and forward rates and yields will adjust very quickly so that similar risk and maturity should be equal to, but opposite in the return is the same for the two transactions sign to, the forward rate discount or premium for the In fact, The forward rate is determined by the following formula foreign currency, except for transaction costs. It holds well for those free-floating currencies. F-51+ 1≈4%-4.3%=-0.3%; disappears in less than one second expect for the transaction cost
2016/11/2 7 4-37 Interest Rates and Exchange Rates • If Janet Yellen hints the Fed will raise $ interest rate, how will RMB respond in the foreign exchange market? • In the capital market, investors arbitrage on interest rates, trying to finance with currencies of low interest and invest in high. (Remember : this may be prohibited by the capital control. ) • Even if not, investors may also encounter exchange rate changes, which may eat all the arbitrage profit. • They need to cover(hedge) the profit in the forward market. Covered Interest Parity • Investor has USD 10 million to put on deposit for 360 days. • Could also buy euro spot, put proceeds on deposit at € Libor and sell balance forward for USD. $/€ Spot $1.550 $/€ 360 day forward $1.548 $ 360-day Libor 4.0% € 360-day Libor 4.3% Which is the better investment? 4-38 Covered Interest Parity • Invest on $ – will have $10*(1+4)=$10.4 million in 360 days • Invest on € – exchange $ to € at the spot rate, get €6.4516 million (=10÷1.55) – will have €6.7290 million in 360 days (=6.4516×1.043). – sell this amount forward at the forward rate and get $10.4165 million (=6.7290×1.548) • The better choice is investing in € – Can also borrow in $ and investing in € interest rate arbitrage! 4-39 4-40 Eurodollar rate = 4.00 % per annum 360 days Dollar money market euro money market $10,000,000 $10,400,000 $10,416,542 S=$1.55//€ €=10M/1.5 =6.4516M €6.7290M F360 ==$1.548/€ x 1.043 x 1.04 Start End Euroeuro rate = 4.30 % per annum Arbitrage Potential Covered Interest Arbitrage (CIA) 4-41 Covered Interest Parity and Forward Rate • This cannot persist as it represents a risk free arbitrage opportunity. • Spot and forward rates and yields will adjust very quickly so that the return is the same for the two transactions. • In fact, The forward rate is determined by the following formula: ଷܨ ୣ୳୰୭/$ = ܵଷ ୣ୳୰୭/$ 1 + ݅$ 1 + ݅௨ = 1.55 ∗ 1 + 4% 1 + 4.3% = 1.5455 < 1.548 ிିௌ ௌ = ଵାସ% ଵାସ.ଷ% − 1 ≈ 4% − 4.3% = −0.3% ; ܨ ≈ 1.55 ∗ 1 − 0.3% = 1.5454 *In this example, € in the forward market is more expensive than predicted by the formula, so we buy € in the spot market and sell in the forward to make a profit. In real life, the spread disappears in less than one second expect for the transaction cost. Forward Rate and Interest Rate Parity • Interest Rate Parity (IRP) – The difference in the national interest rates for securities of similar risk and maturity should be equal to, but opposite in sign to, the forward rate discount or premium for the foreign currency, except for transaction costs. – It holds well for those free-floating currencies. 4-42
Reform of rmb Exchange Rate Regime 4.3 History of RMB Exchange Rate orm Official Rate and Internal Settlement Rate: 1978-1985 994Md200 ed Floating Md2005-AG.20 1953-1984 1986-1993 Phase I(1953-1978) vap markets established since 1986, the rate determined by buyers and sellers, constant depreciation of RMB albeit Official rate kept depreciating (partially due to inflation), Phase(1978-1984) with official adjustment, 5.22 in the end of 1990 Frequent intervention by SAFE on behalf of PBoC on the Reform and opening door policy started in 1978 swap center n intemal settlement rate(2.8 )introduced in 1981 Large difference in the rates: 5.72 vS 8.7 in the end of 1993 Official rate(1.5) published by SAFE, used only for non- Internal settlement rate discontinued in 1985; all rate against USD on January 1st, 1994 at the prevailing swap transactions done at the official rate(2. 8) 1994-Mid2005 RMB Rate: 1994 to 2005 Market-based managed floating system as stated, still with band of 0. 3% either side after 1997(8. 296-8.2771 rong commitment of intervention from PBoc acto peg according hanghai Forex center and interbank Forex market established Retention quota for enterprises, priority list of forex provision and regulated market access abolished Current account convertibility of RMB achieved on December RMB strengthened 4.8% against dollar during 1994 to 1997 China entered WTO on Decllth, 2001, promised opening the §§§看§§§§§
2016/11/2 8 4.3 History of RMB Exchange Rate Reform 4-43 Reform of RMB Exchange Rate Regime 4-44 1953－1978: Single Peg and a Basket Peg Official Rate and Internal Settlement Rate: 1978－1985 1986-1993: Dual Rates System 1994-Mid 2005:Market-based Managed Floating Mid 2005-AUG. 2015 (Appreciation) Aug. 2015- 4-45 1953-1984 • Phase I (1953-1978) – officially determined exchange rate , single peg in a strictly planned economy – No foreign debt and FDI, foreign trade controlled by stateowned foreign trade companies • Phase II (1978-1984) – Reform and opening door policy started in 1978 – An internal settlement rate (2.8) introduced in 1981 – Official rate (1.5) published by SAFE, used only for nontrade-related transactions – Internal settlement rate discontinued in 1985; all transactions done at the official rate (2.8) 4-46 1986-1993 • Swap markets established since 1986, the rate determined by buyers and sellers, constant depreciation of RMB albeit PBoC’s intervention • Official rate kept depreciating (partially due to inflation), with official adjustment, 5.22 in the end of 1990 • Frequent intervention by SAFE on behalf of PBoC on the swap center • Large difference in the rates: 5.72 vs. 8.7 in the end of 1993 • Official rate and swap market rate integrated as reference rate against USD on January 1st, 1994 at the prevailing swap market rate (8.7) 4-47 1994 - Mid 2005 • Market-based managed floating system as stated, still with strong commitment of intervention from PBoC • Shanghai Forex center and interbank Forex market established • Retention quota for enterprises, priority list of forex provision and regulated market access abolished • Current account convertibility of RMB achieved on December 1st, 1996 • RMB strengthened 4.8% against dollar during 1994 to 1997 from 8.7 to 8.3 • China entered WTO on Dec11th, 2001, promised opening the financial market in 5 years RMB Rate: 1994 to 2005 4-48 8.2 8.3 8.4 8.5 8.6 8.7 8.8 94/1/1 94/7/1 95/1/1 95/7/1 96/1/1 96/7/1 97/1/1 97/7/1 98/1/1 98/7/1 99/1/1 99/7/1 00/1/1 00/7/1 01/1/1 01/7/1 02/1/1 02/7/1 03/1/1 03/7/1 04/1/1 04/7/1 05/1/1 05/7/1 Floating band of 0.3% either side after 1997(8.296-8.277) de facto peg according to IMF?
Market Pressure on rmb reform Market Pressure on rMb reform BOP of China 1991"2016(sbln) FX Reserve 2001"2016M9(Sbln) NM Erre and masers Cost of Maintaining Back to the Impossible Trinity a Stable Exchange Rate The money becomes funds outstanding for foreign exchange ° monetary base For the economy: either inflation or asset bubbles Pure floating Cost of sterilizing became higher when more hot money Low interest rate: borrow for firms and ouseholds and to lend for commercial banks Cost of Maintaining Cost of Maintaining Stable Exchange Rate a Stable Exchange Rate Real estate market came to a boom since 2001 Central Bank Balance Sheet for China(2004-2015) Investment channels for foreign capital: FDI? Security narket? Real estate market? More challenges China entered WTO at Dec 2001, promising to open he financial markets in 5 years aJt 099 101: 1a 14 071 D a7 a au L10 a L14 L More than 20 regulation items in capital flowing L2112151B been abolished anking sector was still weak; joint-stock reform in the banking sector started from 2001 m:田田田B出田 Net Finarcial Assets000a自020050200a00200200xf
2016/11/2 9 Market Pressure on RMB Reform: BOP of China 1991~2016($bln) 49 -200 -100 0 100 200 300 400 500 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Current Account Capital and Financial Account Net Error and Omissions *2016-1H is simply doubled to get the whole year data. Market Pressure on RMB Reform: FX Reserve 2001~2016M9($bln) 50 212 217 423 610 819 1,066 1,528 1,946 2,399 2,847 3,197 3,312 3,820 3,840 3,330 3,166 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Back to the Impossible Trinity 4-51 Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility 4-52 Cost of Maintaining a Stable Exchange Rate • More capital came during 2002 to 2004 expecting RMB revaluation • SAFE was forced to buy to stabilize the exchange rate • The money becomes funds outstanding for foreign exchange in PBoC’s B/S • monetary base enlarged — loss of monetary independence – For the economy: either inflation or asset bubbles – Cost of sterilizing became higher when more hot money came • Low interest rate: strong incentive to borrow for firms and households and to lend for commercial banks 4-53 Cost of Maintaining a Stable Exchange Rate • Real estate market came to a boom since 2001 • Investment channels for foreign capital: FDI? Security market? Real estate market? • More challenges – China entered WTO at Dec 2001, promising to open the financial markets in 5 years; – More than 20 regulation items in capital flowing been abolished; – Banking sector was still weak; joint-stock reform in the banking sector started from 2001 Cost of Maintaining a Stable Exchange Rate in trillion Yuan 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total Assets 5.11 6.20 7.87 10.37 12.86 16.91 20.71 22.75 25.93 28.10 29.45 31.73 33.82 31.78 Foreign Assets 2.32 3.11 4.70 6.33 8.58 12.48 16.25 18.53 21.54 23.79 24.14 27.22 27.86 25.38 Treasury Bonds 0.29 0.29 0.30 0.29 0.29 1.63 1.62 1.57 1.54 1.54 1.53 1.53 1.53 1.53 Credit to Commercial Banks 1.00 1.06 0.94 0.78 0.65 0.79 0.84 0.72 0.95 1.02 1.67 1.31 2.5 2.66 Credit to Other Financial Institutions 0.74 0.75 0.90 1.33 2.20 1.30 1.19 1.16 1.14 1.07 1.00 0.89 0.78 0.67 others 0.76 0.99 1.03 1.63 1.14 0.71 0.80 0.78 0.76 0.68 1.10 0.78 1.14 1.53 Liabilities 5.09 6.18 7.84 10.35 12.84 16.89 20.69 22.73 25.91 28.08 29.43 31.71 33.80 31.76 Monetary Base 4.51 5.28 5.89 6.43 7.78 10.15 12.92 14.40 18.53 22.46 25.23 27.10 29.41 27.64 Central Bank Bills 0.15 0.30 1.11 2.03 2.97 3.45 4.58 4.21 4.05 2.33 1.39 0.78 0.65 0.66 Central Government Deposit 0.31 0.50 0.58 0.75 1.02 1.71 1.70 2.12 2.43 2.27 2.08 2.86 2.27 2.72 Foreign Liabilities 0.04 0.05 0.06 0.06 0.09 0.09 0.07 0.08 0.07 0.27 0.15 0.28 0.18 0.18 Others 0.08 0.05 0.21 1.06 0.97 1.48 1.42 1.93 0.82 0.75 0.58 0.69 1.29 0.56 Net Financial Assets 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 4-54 Central Bank Balance Sheet for China(2004-2015)
Cost of Maintaining a Stable Exchange Rate Reform on July 21st, 2005 Reform in 2005> tried to alleviate the pressure RMB would no longer be pegged to the us dollar but a basket of currencies and the rmb exchange rate regime will be improved with greater flexibility RMB rate was adjusted to 8. 11/ US dollar at the time f 19: 00 hours of July 21, 2005 Closing of the market on each working day central parity for the trading against t Reform on july 21st, 2005 Further reforms The daily trading price of the USD against RMB will 2005-9-24, daily trading band for RMB and non-dollar continue to be allowed to float within a band of span currencies widen fron±0.15%to±03% t 0. 3% around the central parity PBOC is responsible for maintaining the RMB trading was introduced exchange rate basically stable at an adaptive and equilibrium level USD wou| d be widened fron±0.3%to±0.5% PBOC will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial MAA A RMB Rate before 2008 Financial Crisis Impossible Trinity after the 2005 Reform Expectation for appreciation attracted more capital after 2005 Hot money came as also as "fake exporting Larger pressure for PBoc to sterilize the forex reserve more Inflation did not The Chinese government began to raise interest rate since the second half of 2006 But, the 2008 global financial crisis came up 10
2016/11/2 10 Cost of Maintaining a Stable Exchange Rate 4-55 Reform on July 21st, 2005 • Reform in 2005 tried to alleviate the pressure • RMB would no longer be pegged to the US dollar but a basket of currencies and the RMB exchange rate regime will be improved with greater flexibility. • RMB rate was adjusted to 8.11/US dollar at the time of 19:00 hours of July 21, 2005. • Closing of the market on each working day will be the central parity for the trading against the RMB on the following working day. 4-56 Reform on July 21st, 2005 • The daily trading price of the USD against RMB will continue to be allowed to float within a band of span ± 0.3% around the central parity. • PBOC is responsible for maintaining the RMB exchange rate basically stable at an adaptive and equilibrium level. • PBOC will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation. 4-57 Further Reforms • 2005-9-24, daily trading band for RMB and non-dollar currencies widen from ±0.15% to ±0.3% • 2006-4-6, market-maker mechanism for RMB fixing and trading was introduced. • 2007-5-18, PBOC announced daily trading band for RMB and USD would be widened from ±0.3% to ±0.5% 4-58 4-59 RMB Rate before 2008 Financial Crisis 6.80 7.00 7.20 7.40 7.60 7.80 8.00 8.20 2005/7/22 2006/1/20 2006/7/21 2007/1/19 2007/7/20 2008/1/18 2008/7/18 4-60 Impossible Trinity after the 2005 Reform • Expectation for appreciation attracted more capital after 2005 • Hot money came as also as “fake exporting” • Larger pressure for PBoC to sterilize the forex reserve, more money issuing • Overheating in the economy – Real estate boom – stock market bubble in 2007 – Inflation did not come up until 2007 • The Chinese government began to raise interest rate since the second half of 2006. • But, the 2008 global financial crisis came up!