2015/7/22 Fudan International Foreign Exchange Markets Summer session 2015 Chinese financial markets one currency will be delivered for some other currency at a specified date. art 4: RMB Exchange Rate Reform reign Exchange Markets the exchange purchasing and sellin Volume of currency transactions ebbs and flows July 6 .July 31 udan University, Shanghai, China across the globe as the major currency trading enters open and close throughout the day. easuring Foreign Exchange Market Activity Average Electronic Conversions Per Hour Transactions in the Interbank market Transactions within the interbank market can be executed on a spot, forward, or swap basis delivery of foreign exchange A swap transaction is the simultaneous exchange of one foreign currency for another ia th [lasts"So Transactions in the Interbank market Transactions in the Interbank Market A Spot transaction in the interbank market is the Forward transaction(outright forward requires elivery at a future value date of a specified amount ayment between banks to take place, normally, on of one currency for a specified amount of another The date of settlement is often referred to the value The exchange rate is established at the time of the settled through the computerized clearing House es are usually qu for value Interbank Payment Systems(CHIPS)in NY dates of one, two, three six and twelve months
2015/7/22 1 Fudan International Summer Session 2015 Chinese Financial Markets Part 4: RMB Exchange Rate Reform By Zhang Xiaorong July 6th - July 31st Fudan University, Shanghai, China 4-1 Foreign Exchange Markets • A foreign exchange transaction is an agreement between a buyer and a seller that a fixed amount of one currency will be delivered for some other currency at a specified date. • Foreign Exchange Markets are the “markets” where the exchange purchasing and selling take place. • Features : global, invisible, round-the-clock • Volume of currency transactions ebbs and flows across the globe as the major currency trading centers open and close throughout the day. 4-2 4-3 Measuring Foreign Exchange Market Activity: Average Electronic Conversions Per Hour 0 5,000 10,000 15,000 20,000 25,000 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Greenwich Mean Time Tokyo opens Asia closing 10 AM In Tokyo Afternoon in America London closing 6 pm In NY Americas open Europe opening Lunch In Tokyo Source: Federal Reserve Bank of New York, “The Foreign Exchange Market in the United States,” 2001, www.ny.frb.org. Transactions in the Interbank Market • Transactions within the interbank market can be executed on a spot, forward, or swap basis – A spot transaction requires almost immediate delivery of foreign exchange – A forward transaction requires delivery of foreign exchange at some future date – A swap transaction is the simultaneous exchange of one foreign currency for another 4-4 Transactions in the Interbank Market • A Spot transaction in the interbank market is the purchase of foreign exchange, with delivery and payment between banks to take place, normally, on the second following business day. • The date of settlement is often referred to the value date. • This is the date when most dollar transactions are settled through the computerized Clearing House Interbank Payment Systems (CHIPS) in NY 4-5 Transactions in the Interbank Market • Forward transaction (outright forward) requires delivery at a future value date of a specified amount of one currency for a specified amount of another currency. • The exchange rate is established at the time of the agreement, but payment and delivery are not required until maturity. • Forward exchange rates are usually quoted for value dates of one, two, three, six and twelve months. 4-6
2015/7/22 Transactions Transactions in the Interbank Market the Interbank Market transaction in the interbank market is the NDF (non-deliverable forwards simultaneous purchase and sale of a given amount of foreign exchange for two different value dates Both purchase and sale are conducted with the same contracted offshore and beyond the reach and egulatory frameworks of the home country - profit or loss at the time at the settlement date is This transaction occu he same time and with calculated by taking the difference between the exchange rate exposure agreed upon exchange rate and the spot rate at the time of settlement for an agreed upon notional amount of funds Market Size by daily Turnover(2013) Market Size by Instruments (2013) Daily Turnover by Instruments(in Billion Hil wal Survev 2013 tradional F markets and aprons and other producTs Forein金 schange?≤ Market Size by Instruments(2013) Major currencies
2015/7/22 2 Transactions in the Interbank Market • A swap transaction in the interbank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. • Both purchase and sale are conducted with the same counterpart • A common type of swap is a spot against forward, but can also be forward against forward • This transaction occurs at the same time and with the same counterpart, so the dealer incurs no exchange rate exposure 4-7 Transactions in the Interbank Market • NDF (non-deliverable forwards) – cash-settled ( in US$) short-term forward contract on a thinly traded or non-convertible foreign currency – contracted offshore and beyond the reach and regulatory frameworks of the home country governments – profit or loss at the time at the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of settlement, for an agreed upon notional amount of funds. 4-8 Market Size by Daily Turnover(2013) 1,527 1,239 1,934 3,324 3,971 5,345 ... 1,000 2,000 3,000 4,000 5,000 6,000 1998 2001 2004 2007 2010 2013 Market Turnover Daily Turnover (in $billion) 4-9 Source: BIS Triennial Survey 2013 traditional FX markets and options and other products included Market Size by Instruments (2013) 568 386 631 1,005 1,488 2,046 128 130 209 362 475 680 734 656 954 1,714 1,759 2,228 ... 500 1,000 1,500 2,000 2,500 1998 2001 2004 2007 2010 2013 Spot transactions Outright forwards Foreign exchange swaps Daily Turnover by Instruments (in $billion) 4-10 Market Size by Instruments (2013) 4-11 Major Currencies Currency distribution of global foreign exchange market turnover(in $billion) Net-net basis,1 percentage shares of average daily turnover in April2 Currency 1998 2001 2004 2007 2010 2013 Share Rank Share Rank Share Rank Share Rank Share Rank Share Rank USD 86.8 1 89.9 1 88.0 1 85.6 1 84.9 1 87.0 1 EUR ... 32 37.9 2 37.4 2 37.0 2 39.1 2 33.4 2 JPY 21.7 2 23.5 3 20.8 3 17.2 3 19.0 3 23.0 3 GBP 11.0 3 13.0 4 16.5 4 14.9 4 12.9 4 11.8 4 AUD 3.0 6 4.3 7 6.0 6 6.6 6 7.6 5 8.6 5 CHF 7.1 4 6.0 5 6.0 5 6.8 5 6.3 6 5.2 6 CAD 3.5 5 4.5 6 4.2 7 4.3 7 5.3 7 4.6 7 MXN³ 0.5 9 0.8 14 1.1 12 1.3 12 1.3 14 2.5 8 CNY³ 0.0 30 0.0 35 0.1 29 0.5 20 0.9 17 2.2 9 NZD³ 0.2 17 0.6 16 1.1 13 1.9 11 1.6 10 2.0 10 SEK 0.3 11 2.5 8 2.2 8 2.7 9 2.2 9 1.8 11 RUB³ 0.3 12 0.3 19 0.6 17 0.7 18 0.9 16 1.6 12 HKD³ 1.0 8 2.2 9 1.8 9 2.7 8 2.4 8 1.4 13 NOK³ 0.2 15 1.5 10 1.4 10 2.1 10 1.3 13 1.4 14 SGD³ 1.1 7 1.1 12 0.9 14 1.2 13 1.4 12 1.4 15 Others TOTAL 200% 200% 200% 200% 200% 200% 1 Adjusted for local and cross-borderinter-dealer double-counting (ie “net-net” basis). 2 Because two currencies are involved in each transaction,the sum of the percentage shares of individual currenciestotals 200% instead of 100%. 3 Turnoverfor years priorto 2013 may be underestimated owing to incomplete reporting of offshore trading in previoussurveys. Methodological changesin the 2013 survey ensured more complete coverage of activity in emergingmarket and other currencies 4-12
Major Currency Pairs IMF Exchange Rate Regime N averages in April, in billons of us c No Separate Legal Tender; Currency Board co%10% 10 IMF Exchange Rate Regime IMF Exchange Rate Regime Classification Classification Devaluation of a Currency de jure classification(1974-1998) fers to a drop in foreign exchange value of a AF judges the regime based on the stated urgency that is pegged to gold or another currency commitment of the central bank o The opposite is revaluation de facto classification(since 1999) Weakening, deterioration, or depreciation of a IMF began to characterize countries regime based on their de facto policies after Asian Crisis refers to a drop in the foreign exchange value of a o Available information on each countrys exchange rate and monetary policy framework; observed o The opposite is strengthening or appreciation movements on reserves and official and secondary market rates; quantitative and qualitative analysis IMF Exchange Rate Regime Classification Choice of Exchange Rate Regime A nation's choice as to which currency regim llow reflects national priorities about all facets of interest rate levels, trade balances, and economic The choice between fixed and flexible rates may change over time as priorities change Increasing capital mobility complicates the choices
2015/7/22 3 Major Currency Pairs 4-13 Global foreign exchange market turnover by currency pair(in $billion) Net-net basis,1 daily averages in April, in billions of US dollars and percentages Currency pair 2001 2004 2007 2010 2013 Amount % Amount % Amount % Amount % Amount % USD / EUR 372 30.0 541 28.0 892 26.8 1,098 27.7 1,289 24.1 USD / JPY 250 20.2 328 17.0 438 13.2 567 14.3 978 18.3 USD / GBP 129 10.4 259 13.4 384 11.6 360 9.1 472 8.8 USD / AUD 51 4.1 107 5.5 185 5.6 248 6.3 364 6.8 USD / CAD 54 4.3 77 4.0 126 3.8 182 4.6 200 3.7 USD / CHF 59 4.8 83 4.3 151 4.5 166 4.2 184 3.4 USD / CNY ... ... ... ... ... ... 31 0.8 113 2.1 EUR / JPY 36 2.9 61 3.2 86 2.6 111 2.8 147 2.8 EUR / GBP 27 2.1 47 2.4 69 2.1 109 2.7 102 1.9 EUR / CHF 13 1.1 30 1.6 62 1.9 71 1.8 71 1.3 EUR / AUD 1 0.1 4 0.2 9 0.3 12 0.3 21 0.4 EUR / NOK ... ... ... ... ... ... ... ... 20 0.4 EUR / CAD 1 0.1 2 0.1 7 0.2 14 0.3 15 0.3 Others TOTAL 100% 100% 100% 100% 100% IMF Exchange Rate Regime Classification • Hard Peg(2) – No Separate Legal Tender; Currency Board • Soft Peg(4) – Peg to a Single Currency, Peg to a Composite of Currencies, Crawling Pegs and Bands, Limited Flexibility • Floats(2) – Managed Floating; Independently Floating 4-14 IMF Exchange Rate Regime Classification — 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 4-15 IMF Exchange Rate Regime Classification — de jure classification (1974-1998) ◦ 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 4-16 IMF Exchange Rate Regime Classification 4-17 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. • Increasing capital mobility complicates the choices after 1970s. 4-18
2015/7/22 The Impossible Triangle The Impossible Triangle The forces of eco simultaneous achievement of all three controls Exchange Exchange Pure floating Monetary tion Full financial Inertion tegration he Impossible Triangle Prices and Exchange Rates Vhere will China be? re their any fundamentals of exchange rate Commodity prices and interest rates in the tw countries matter. w of One Price(LOP Pine oting the sale or transportation costs of moving the product between markets, arbitrage would soon equalize the products price in the markets Prices and exchange Rates Prices and Exchange Rates If LoP were true for all goods and services, the Real rate is usually different from 1, or, ppp does not exchange rate could be found from any individual set hold well in the real life of prices in the two countries But ppp rate provides a benchmark Since the rate is urgencies can be evaluated against other currency (purchasing power) it is also called the alues to determine relative purchasing power. purchasing power parity(Ppp)exchange rate Real rate in international economics is defined as the We can also discover whether a nations exchange PpP rate over nominal rate rate is overvalued"or undervalued" in terms of ppp If the real rate l is 1, it indicates that ppp holds in the Example: Big Mac Index and Starbucks Index two countries xample: CBN Cost of Living Index
2015/7/22 4 The Impossible Triangle • The forces of economics do not allow the simultaneous achievement of all three 4-19 Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility The Impossible Triangle 4-20 Where are the US, France and China? Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility The Impossible Triangle 4-21 Where will China be? Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility Prices and Exchange Rates • Are their any fundamentals of exchange rate? • Commodity prices and interest rates in the two countries matter. • Law of One Price (LOP) ◦ 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. P $ x S = P¥ 4-22 Prices and Exchange Rates • If LOP were true for all goods and services, the exchange rate could be found from any individual set of prices in the two countries. • Since the rate is given by comparing the commodity prices (purchasing power), it is also called the purchasing power parity (PPP) exchange rate. • Real rate in international economics is defined as the PPP rate over nominal rate. • If the real rate 1 is 1, it indicates that PPP holds in the two countries. 4-23 Prices and Exchange Rates • Real rate is usually different from 1, or, PPP does not hold well in the real life. • But PPP rate provides a benchmark: individual currencies can be evaluated against other currency values to determine relative purchasing power. • We can also discover whether a nation’s exchange rate is “overvalued” or “undervalued” in terms of PPP. • Example: Big Mac Index and Starbucks Index • Example: CBN Cost of Living Index 4-24
2015/7/22 Big Mac Index and starbucks Index ig Mac Index -Undervaluation Each year, the Economists releases its Big Mac Index or most currencies to illustrate how much they are over-or under-valued by PPP. Is Big Mac a good product to compare the purchasing HKS16. power of the world s currencies Ringgit 7-35 The Economists also presented a Starbucks (tall Latte) Rand 19.95 Index in 2004 and GDP per-capita adjusted Big Mac Rupiah 22,534 index in 2011 NTS 75.0 Big Mac Index -Overvaluation RMB Big Mac Index 2003 PPP rate=99/271=365 States 977604 (nominal rate 8. 27, undervalued by 56%) 2011 PPP rate=147/407=360 (nominal rate 6.5, undervalued by 45%; but overvalued by 3% when GDP per capita is adjusted 2013 PPP rate=16.1/4.56=353 (nominal rate 6. 28, undervalued by 43%) 2015 PPP rate=17.2/4.79=3.59 E349 4431.20127 (nominal rate 6. 21, undervalued by 42%) CBN Cost of Living Index 2010 History of RMB Exchange Rate Regime ingle Peg and a Basket Peg 1986-1993 Market-based Managed Floating 994Mid2005 id2005
2015/7/22 5 Big Mac Index and Starbucks Index • Each year, the Economists releases its Big Mac Index for most currencies to illustrate how much they are over- or under-valued by PPP. • Is Big Mac a good product to compare the purchasing power of the world’s currencies? • The Economists also presented a Starbucks (tall Latte) Index in 2004 and GDP per-capita adjusted Big Mac index in 2011. 4-25 Big Mac Index - 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 4-26 Big Mac Index - Overvaluation 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 Colombia Peso 8,400 4.54 2001.00 1852 8 Euro area € 3.49 4.43 1.20 1.27 6 Japan Yen 320 4.16 76.24 76.9 4-27-1 RMB Big Mac Index • 2003 PPP rate=9.9/2.71=3.65 (nominal rate 8.27, undervalued by 56%) • 2011 PPP rate=14.7/4.07=3.60 (nominal rate 6.5, undervalued by 45%; but overvalued by 3% when GDP per capita is adjusted) • 2013 PPP rate=16.1/4.56=3.53 (nominal rate 6.28, undervalued by 43%) • 2015 PPP rate=17.2/4.79=3.59 (nominal rate 6.21, undervalued by 42%) 4-28 Items Brands Descriptions Shanghai New York PPP Rate RMB Under/Over （RMB） （USD） （USD） Valuation(%) Clothing Shirts H&M white cotton shirt for men 149 28 5.32 -21% Shoes Crocs Tully for women 249 29.99 8.3 23% Food&Drugs Hamburgers McDonald's Big Mac 13.5 3.75 3.6 -47% Coffee Starbucks small regular 15 1.97 7.61 12% Coke Coke Cola 330ml can classic 2 1.2 1.67 -75% Milk Local Famous Brand 1L whole milk 10 1 10 48% Beer Budweiser 330ml can 5.3 1 5.3 -22% Cigarettes Marlboro 20 cigarettesin one package 15 10 1.5 -78% Drugs for cold TYLENOL 10 tablets in one package 13 2.69 4.83 -29% Lodging Average Rents None Two-bedroomin downtown 3000 4000 0.75 -89% Economic hotels Local Famous Brand Listing price 200 164.14 1.22 -82% 5 Star Hotels Hilton Listing price 2200 299 7.36 9% Transportation Subway Local Famous Brand Lowest price per travel 3 2.25 1.33 -80% Gasoline None 1L (#93 or #95) 6.7 0.53 12.64 87% Services Internet Access Local Famous Brand Monthly fee 150 59 2.54 -62% Hous-keeping None Salary per hour 15 15 1 -85% Mail Local Famous Brand Local (first class) 0.8 0.44 1.82 -73% Movies Avatar IMAX 150 15 10 48% Musical Shows Lion King Min Price 180 72.5 2.48 -63% Newspaper (Fiance&Economics) China Business News one copy 2 2 1 -85% Magzine (fashion) Vogue one copy 20 3.99 5.01 -26% Body exercise Local Famous Brand Normal annual card 3000 948 3.16 -53% Undergraduate Education Fudan University Tuition fee per year 7500 51063 0.15 -98% （Journalism/Public Media） (Columbia University) Haircut None Washing, cutting and drying 20 23 0.87 -87% Others Sofa IKEA KARLSTAD two-seatsofa 2499 479 5.22 -23% Computers Laptop (Macintosh) 2.13GHz, 2GB, 128GB 14498 1799 8.06 19% Mobiles iPhone 3G 6999 399 17.54 159% Shampoo Rejoice 400ml, bottle 28 4.99 5.61 -17% Flowers None 20 rosesin one package 100 16.99 5.89 -13% Average 4.89 -28% CBN Cost of Living Index 2010 4-29 4-30 History of RMB Exchange Rate Regime Single Peg and a Basket Peg 1953－1978 Official Rate and Internal Settlement Rate 1978－1985 Dual Rates System 1986-1993 Market-based Managed Floating 1994-Mid 2005 After Mid 2005
2015/7/22 Phase:1953-1978 Phase ll:1978-1985 or policy started in strictly planned economy An internal settlement rate introduced in 1981 Occasional adjustments according to ec State-owned companies were required to purchase needs and political considerations FX from BOC for foreign trade but with retention Peg to a basket of internationally traded currencies after 1973 only through the arrangement of saFe. state-owne Official rate still published by saFe, used only for RMB overvalued, the rate served as a tool of on-trade- related transactio accounting, very weak relation with foreign trade Phase l:1978-1985 Phase ll:1986-1993 Large difference in the two rates: 2.8 VS. 1.5 in the Swap markets established since 1986, the rate beginning of 1981 determined by buyers and sellers Official rate adjusted from 1981 to 1985 with the ppreciation of us dollar, two rates got closer established in 4 southern cities in China ternal settlement rate discontinued in the Official rate kept depreciating (partially due to beginning of 1985 inflation), 5.22 in the end of 1990 All transactions done at the official rate 2.8 published Frequent intervention by SaFE on behalf of PBoC on he swap center Phase ll:1986-1993 Phase Iv: 1994-Mid 2005 Constant depreciation of RMB in swap center leading arket-based managed floating system as stated, to official adjustment in the end of 1993 ill with strong commitment of intervention from Large difference in the rates: 5.72 vS 8.7 in the end shanghai Forex center and interbank Forex market reference rate against USD by PBoc rate on January Retention quota for enterprises, priority list of forex st, 1994 at the prevailing swap market rate(8.7) provision and regulated market access abolished Different regulations for domestic and foreign banks
2015/7/22 6 4-31 Phase I: 1953-1978 • Officially determined exchange rate , single peg in a strictly planned economy • Occasional adjustments according to economic needs and political considerations • Peg to a basket of internationally traded currencies after 1973 • No foreign debt and FDI, foreign trade controlled by state-owned foreign trade companies • RMB overvalued, the rate served as a tool of accounting, very weak relation with foreign trade 4-32 Phase II: 1978-1985 • Reform and opening door policy started in 1978 • An internal settlement rate introduced in 1981 • State-owned companies were required to purchase FX from BOC for foreign trade, but with retention quota • Buying and selling of FX among enterprises allowed only through the arrangement of SAFE. • Official rate still published by SAFE, used only for non-trade-related transactions 4-33 Phase II: 1978-1985 • Large difference in the two rates: 2.8 vs. 1.5 in the beginning of 1981 • Official rate adjusted from 1981 to 1985 with the appreciation of US dollar, two rates got closer • Internal settlement rate discontinued in the beginning of 1985 • All transactions done at the official rate 2.8 published by SAFE 4-34 Phase III: 1986-1993 • Swap markets established since 1986, the rate determined by buyers and sellers • In 2 years, more than 80 swap markets were established in 4 southern cities in China. • Official rate kept depreciating (partially due to inflation), 5.22 in the end of 1990 • Frequent intervention by SAFE on behalf of PBoC on the swap center 4-35 Phase III: 1986-1993 • Constant depreciation of RMB in swap center leading to official adjustment in the end of 1993 • 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 by PBoC rate on January 1st, 1994 at the prevailing swap market rate (8.7) 4-36 Phase IV: 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 • Different regulations for domestic and foreign banks still existed
2015/7/22 haseⅣv:1994-Mid2005 RMB Rate from 1994 to mid 2005 account convertibility of RMB achieved on mber 1st. 1996 RMB strengthened 4.8% against dollar during 1994 to 1997 from 8.7 to 8.3 China entered WTO on Decl1th, 2001, promised opening the financial market in 5 years Floating band of 0.3% either side after 1997(8.296- de facto peg according to IMF? 氵§§§§§§§喜 BOP of China: 1991 2014 (in $bln FX Reserve: 2001"2014 (in Sbln) 3.000 D6101112 capital and Finandal Account Net Error fOreign Exchange Rserve External Pressure from trade partners Back to the Impossible Triangle laza Accord in 1985, bubbles economy from 1987 to 1989, recession in 1990 Full capital controls Mometary Exchange EU and UK Pune Noating Chinas cheap money", Financial Times, Aug 7th, 2001 Monetary iio Peg to USD led to rmb depreciation against other Full financal
2015/7/22 7 4-37 Phase IV: 1994 - Mid 2005 • 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 • Floating band of 0.3% either side after 1997(8.296- 8.277) • de facto peg according to IMF? RMB Rate from 1994 to Mid 2005 4-38 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 BOP of China: 1991~2014 (in $bln) -200 `4-39 -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 Current Account capital and Financial Account Net Error and Omissions FX Reserve: 2001~2014 (in $bln) 4-40 212 217 423 610 819 1,066 1,528 1,946 2,399 2,847 3,197 3,312 3,820 3,840 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 Foreign Exchange Reserve External Pressure from Trade Partners • Japan – Plaza Accord in 1985, bubbles economy from 1987 to 1989, recession in 1990s • US – USD depreciated since 2002, slight recession after 2001, huge trade deficit with China, unemployment 5.99% in 2003 • EU and UK – “China’s cheap money”, Financial Times, Aug 7th, 2001 – Peg to USD led to RMB depreciation against other currencies 4-41 Back to the Impossible Triangle 4-42 Pure floating Full capital controls Monetary independence Monetary union Full financial integration Exchange rate stability Increased capital mobility
2015/7/22 Impossible Triangle: Cost of Impossible Triangle: Cost of Maintaining a Stable Exchange Rate Maintaining a Stable Exchange Rate More capital came during 2002 to 2004 expecting ey came SAFE was forced to buy forex in the market to stabilize Low interest rate: strong incentive to borrow the exchange rate firms and households and to lend for commercial becomes funds outstanding for foreign banks exchange in PBoC's B/S Realestate market came to boom since 2001 vestment channels for foreign capital Result: monetary base enlarged --loss of monetary Security market? For the economy: either inflo or asset bubbles Impossible Triangle: Cost of Maintaining a Stable Exchange Rate Reform on July 21st, 2005 More challenges form in 2005) tried to alleviate the pressure China entered WTo at Dec 2001, promising to RMB would no longer be pegged to the us dollar but open the financial markets in 5 years; a basket of currencies and the rmb excha More than 20 regulation items in capital flowing regime will be improved with greater flexibility. been abolished RMB rate was adjusted to 8. 11/US dollar at the time Banking sector was still weak; joint-stock reform in the banking sector started from 2001 Closing of the market on each working day will be (Big five still dominate the banking system in he central parity for the trading against the RMB terms of total assets and liabilities) on the following working day. Reform on July 21st, 2005 Further Reforms The daily trading price of the USD against RMB will continue to be allowed to float within a band of span currencies widen fron±0.15%to±0.3% t 0.3% around the central pal 006-4-6, market-maker mechanism for rMb fixing and PBoC is responsible for maintaining the RMB trading was introduced change rate basically stable at an adaptive and equilibrium level. PBoc will make adjustment of the RMB exchange AAAT.My development as well as the economic and financial situation 2007-4-18, PBoc announced daily trading band for RMB nd USD widened from±0.3%to±0.5%
2015/7/22 8 4-43 Impossible Triangle :Cost of Maintaining a Stable Exchange Rate • More capital came during 2002 to 2004 expecting RMB revaluation • SAFE was forced to buy forex in the market to stabilize the exchange rate • The money becomes funds outstanding for foreign exchange in PBoC’s B/S • Result: monetary base enlarged —— loss of monetary independence • For the economy: either inflation or asset bubbles 4-44 Impossible Triangle :Cost of Maintaining a Stable Exchange Rate • 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 • Real estate market came to a boom since 2001 • Investment channels for foreign capital – FDI? – Security market? – Real estate market? 4-45 Impossible Triangle :Cost of Maintaining a Stable Exchange Rate • 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 – (Big five still dominate the banking system in terms of total assets and liabilities) Reform on July 21st, 2005 • Reform in 2005à 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. 4-46 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. 4-47 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. • 2007-4-18, PBoC announced daily trading band for RMB and USD would be widened from ±0.3% to ±0.5% 4-48
2015/7/22 RMB Rate before The Impossible Triangle 2008 Financial Crisis after the 2005 Reform Expectation of more appreciation attracting more Larger pressure for PBoc to sterilize forex reserve more money issue Inflation did not come up until 2007-----where did Real estate boom and stock market bubble 20057222006120206/7n212007/n92007/720208/8200878 The 2008 Global financial crisis The 2008 Global Financial Crisis and the chinese economy and the Chinese Economy The Chinese government began to raise interest ra That is specific of this financial crisis? since the second half of 2006 Is it a liquidity shock or demand shock to Chinese The Chinese stock market hit a historical high in October 2007 More evidence supported the demand The 2008 global financial crisis came up in September nd the Chinese government peg RMB again since Economic growth slow down(GDP 9.6%) The Chinese government announced a stimulus Insufficient domestic demand to cut interest rate China's Policies in Handling the Crisis The Impossible Triangle in 2009and2010 Moderately ease"monetary policy: cut interest rate 4-trill package in 2009 and 2010 since oct. 2008 The financial market resumed appreciatio Active" fiscal policy: cut taxes expectation on RMB since mid of 2009 Four-trillion stimulus package announced on no apital inflow recovered--pressure again! 5th 2008 for investment in 2009 and 2010 he government did not allow faster appreciation 1.18 trillion from the central government until mid of 2010 on on railway, highway and airport Specific stimulus plans released in Jan and Feb 2009 Results: overheating economy, real estate bubbles, for ten key industries, including auto iron and steel textile, shipbuilding, etc
2015/7/22 9 4-49 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 The Impossible Triangle after the 2005 Reform • Expectation of more appreciation attracting more capital after 2005 • Hot money came as also as “fake exporting” • Larger pressure for PBoC to sterilize forex reserve, more money issuing • Inflation did not come up until 2007------where did the money go? • Real estate boom and stock market bubble! The 2008 Global Financial Crisis and the Chinese Economy • The Chinese government began to raise interest rate since the second half of 2006. • The Chinese stock market hit a historical high in October 2007. • The 2008 global financial crisis came up in September and the Chinese government peg RMB again since October. • The Chinese government announced a stimulus package totaling 4 trillion yuan on Nov. 5th , and began to cut interest rate. 51 The 2008 Global Financial Crisis and the Chinese Economy • What is specific of this financial crisis? • Is it a liquidity shock or demand shock to Chinese economy? • More evidence supported the demand • For year 2008 – Economic growth slow down (GDP 9.6%) – Exporting declined by 30% – Insufficient domestic demand 4-52 China’s Policies in Handling the Crisis • “Moderately ease” monetary policy: cut interest rate since Oct. 2008 • “Active” fiscal policy: cut taxes • Four-trillion stimulus package announced on Nov 5 th , 2008 for investment in 2009 and 2010 – 1.18 trillion from the central government – 1.5 trillion on railway, highway and airport • Specific stimulus plans released in Jan and Feb 2009 for ten key industries, including auto, iron and steel, textile, shipbuilding, etc. 4-53 The Impossible Triangle in 2009 and 2010 • 4-trill package in 2009 and 2010 • The financial market resumed appreciation expectation on RMB since mid of 2009 • Capital inflow recovered——pressure again! • The government did not allow faster appreciation until mid of 2010 • Plus: quantitative easing in the US • Results: overheating economy, real estate bubbles, inflation
The Impossible Triangle in RMB Rate after 2008 2009and2010 Financial Crisis egan to raise required reserve ratio since early Began to raise interest rate since late 2010 accelerate RMB appreciation after mid of 2010 Exit the 4-trillion stimulus plan since 2011 Further reforms Impossible Triangle and Loss of Mo 2010-4-19, PBoc announced"to proceed further with reform of the rmb exchange rate regime and to enhance the rmb exchange rate flexibility 2012-4-16, PBoc announced daily trading band RMB and USD would be widened from +0.5% to 2014-3-17, PBoc announced daily trading band for RMB and USD would be widened fron±1%to±2% Do you think more reforms will follow? 当罡温溫彐罰 Features of A Bubble Economy Stock Market Three features of bubble economy (experience from rapid and substantial rise in asset price Consequence of Japan s bubble economy Lost decades
2015/7/22 10 The Impossible Triangle in 2009 and 2010 • PBoC’s actions to curb the overheating economy – Began to raise required reserve ratio since early 2010 – Began to raise interest rate since late 2010 • accelerate RMB appreciation after mid of 2010 • Exit the 4-trillion stimulus plan since 2011 4-55 56 RMB Rate after 2008 Financial Crisis 6 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 2008/9/1 2008/12/1 2009/3/1 2009/6/1 2009/9/1 2009/12/1 2010/3/1 2010/6/1 2010/9/1 2010/12/1 2011/3/1 2011/6/1 2011/9/1 2011/12/1 2012/3/1 2012/6/1 2012/9/1 2012/12/1 2013/3/1 2013/6/1 2013/9/1 2013/12/1 2014/3/1 2014/6/1 2014/9/1 2014/12/1 2015/3/1 2015/6/1 Further Reforms • 2010-4-19, PBoC announced “to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility” • 2012-4-16, PBoC announced daily trading band for RMB and USD would be widened from ±0.5% to ±1% • 2014-3-17, PBoC announced daily trading band for RMB and USD would be widened from ±1% to ±2% • Do you think more reforms will follow? 4-57 Impossible Triangle and Loss of Monetary Independence in trillion Yuan 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014* 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 33.93 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 28.00 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 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 2.41 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 0.87 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 1.12 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 33.91 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 28.11 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 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 4.45 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 0.16 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 0.54 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 4-58 Central Bank Balance Sheet for China(2002-2014) *: by the end of Oct in 2014 4-59 Features of A Bubble Economy • Three features of bubble economy (experience from Japan in late 1980s) – rapid and substantial rise in asset prices – the overheating of economic activity – sizable expansion of money supply and credit • Consequence of Japan’s bubble economy – Liquidity trap – Lost decades 4-60 Stock Market