The Evolution of the renminbi Exchange rate The exchange rate regime of the Chinese currency (or renminbi with unit the yuan) track rate regime and a market-based managed floating regir During the early stage of the foundation of the PRC, the exchange rate of the renminbi was adjusted frequently during the period from 1949 to 1952, followed by a relatively stable period from 1953 to 1970. After a drastic currency reform, which transferred 10,000 yuan of old currency to one new yuan, a fixed official rate against the U.S. dollar(USD)was established in January 1970(World Currency Yearbook, 1984). With the suspension of the convertibil ity of the USD into gold on 15 August 1971 (Gowa, J. 1983), the renminbi began to appreciate against the USD. Then the PrC began to list an effective rate for the renminbi against the USD from April 1972. After collapse of the Bretton Woods System the official renminbi rate remained pegged to a basket of 15 currencies until 1980 The most important progress in the exchange rate regime reform was made after the PRC launched its economic reform and opening up policy. In 1980, the renminbi was placed on a dual track system, i. e, the coexistence of the official rate and trade-related settlement rate and coexistence of the official rate and swap market rate, respectively, during 1981-1985 and 1985-1993. Following that, the Chinese currency was pegged to the USd and alle to float with a narrow band between 827 yuan and 862 yuan per hundred USD for than one decade The dual track exchange rate regime The evolution of the renminbi exchange rate regime and determination of the exchange rate are closely related to the economic regime of the prc as a whole. Before 1978, the PRC had a soviet Union style socialist system. Under this system, the relationship between the PRC and major capitalist countries was not so close. This is one of the reasons why its economy lagged behind western countries and why trade and capital flows with overseas were so scarce. To improve this situation, the Prc government had to ad vocate a spirit of self-independence and hard work. Since there were in practice no foreign exchange markets at the time, the exchange rate existed only as a calculation unit and seems unl ikely to have reflected supply and demand relations On 5 January 1980, The State Council issued a decree prohibiting the use of foreign exchange as a means of payment within the territory of the PRC. On 1 April 1980, foreign exchange certificates(also called Waihui Quan), which were equal in value to the renminbi at its effective rate, were issued in exchange for hard currency and put into circulation for use by nonresidents only, for pay ing hotel bills, transportation fares and for purchases the friendship stores(Youyi Shangd ian) On 1 January 1981, a multiple rate structure for the renminbi was created with the introduction of a trade-related internal settlement rate. For internal settlements under the
The Evolution of the Renminbi Exchange Rate The exchange rate regime of the Chinese currency (or renminbi with unit the yuan) has experienced three historical development phases, i.e. a single official rate regime, dual track rate regime and a market-based managed floating regime. During the early stage of the foundation of the PRC, the exchange rate of the renminbi was adjusted frequently during the period from 1949 to 1952, followed by a relatively stable period from 1953 to 1970. After a drastic currency reform, which transferred 10,000 yuan of old currency to one new yuan, a fixed official rate against the U.S. dollar (USD) was established in January 1970 (World Currency Yearbook, 1984). With the suspension of the convertibility of the USD into gold on 15 August 1971 (Gowa, J. 1983), the renminbi began to appreciate against the USD. Then the PRC began to list an effective rate for the renminbi against the USD from April 1972. After collapse of the Bretton Woods System, the official renminbi rate remained pegged to a basket of 15 currencies until 1980. The most important progress in the exchange rate regime reform was made after the PRC launched its economic reform and opening up policy. In 1980, the renminbi was placed on a dual track system, i.e., the coexistence of the official rate and trade-related settlement rate, and coexistence of the official rate and swap market rate, respectively, during 1981–1985 and 1985–1993. Following that, the Chinese currency was pegged to the USD and allowed to float with a narrow band between 827 yuan and 862 yuan per hundred USD for more than one decade. 1 The Dual Track Exchange Rate Regime The evolution of the renminbi exchange rate regime and determination of the exchange rate are closely related to the economic regime of the PRC as a whole. Before 1978, the PRC had a Soviet Union style socialist system. Under this system, the relationship between the PRC and major capitalist countries was not so close. This is one of the reasons why its economy lagged behind western countries and why trade and capital flows with overseas were so scarce. To improve this situation, the PRC government had to advocate a spirit of self-independence and hard work. Since there were in practice no foreign exchange markets at the time, the exchange rate existed only as a calculation unit and seems unlikely to have reflected supply and demand relations. On 5 January 1980, The State Council issued a decree prohibiting the use of foreign exchange as a means of payment within the territory of the PRC. On 1 April 1980, foreign exchange certificates (also called Waihui Quan), which were equal in value to the renminbi at its effective rate, were issued in exchange for hard currency and put into circulation for use by nonresidents only, for paying hotel bills, transportation fares and for purchases at the friendship stores (Youyi Shangdian). On 1 January 1981, a multiple rate structure for the renminbi was created with the introduction of a trade-related internal settlement rate. For internal settlements under the
foreign exchange allotment quota, the rate was set at RMB2.80 per USD. Generally speaking, this rate was formed by add ing to the effective rate an"equalization price"for balancing export and import profits and losses, and was applied to all national enterprises and corporations engaging in trade It was also applied to receipts and expenditures in foreign exchange for trade-related transactions in invisibles, such as shipping and insurance The trad ing business was done under an experimental trad ing system for foreign exchange, which was established by the bank of China in a few areas, such as beijing, guangdong Hefei, Shanghai, and Tianjin. National enterprises holding foreign exchange earned through the system of retention quotas were permitted to sell it to other national enterprises that had a quota for spending foreign exchange. For dealings under the foreign exchange retention scheme, the Bank of China acted as a broker, charging 0. 1-0.3 per cent. This process, and a breakthrough was made in the reform of the exchange rate mechanist ming indicates that the market mechanism was introduced into the exchange rate forming On 1 January 1985, the trade-related internal settlement exchange rate was abolished and the effective rate came to govern all trade but a foreign exchange retention quota remained for a portion of export proceeds. On 20 November 1985, authorization was granted for Chinese residents to hold foreign exchange, to open foreign exchange accounts, and to deposit and withdraw funds in fo In November 1986, a foreign exchange swap rate was created, based on rates essentially agreed to between buyers and sellers. This became available for foreign investment corporations at over 100 foreign exchange adjustment centers and for Chinese enterprises in the four Special Economic Zones(Shantou, Shenzhen, Xiamen, and Zhuhai) initially and then in 1988 it was expanded to all domestic entities authorized to retain foreign exchange earnings( World Currency Yearbook 1988-1989). The swap rate and official rate coexisted until the single rate regime was established in 1994 The transition period of 1985-1993 had two features. First, in accordance with the aboy statement, the renminbi had two prices vis-a-vis foreign currencies. The official price of the USD was lower than the swap rate, implying that the renminbi was set artificially high The official rate was basically determined by the exchange cost of export goods plus a certain amount of profit. This is actually a practical application of a theory called tradable goods purchase power parity (Yang Fan, 1999)a variant of purchase power parity Second, the overvaluation of the renminbi made the currency face depreciation pressure, and indeed it followed a path of depreciation. While the official exchange rate and swap market exchange rate were approaching one another before 1992, the economic overheating driven by Deng Xiaopings South China Tour speeded up the renminbi depreciation process and widened the difference between the official rate and swap market rate. Simultaneously, the market exchange rate overshot and the renminbi was severely undervalued, as will be shown in an empirical study below. The integration of the dual exchange rate system in 1994 can be viewed as a continuing effort toward the
foreign exchange allotment quota, the rate was set at RMB2.80 per USD. Generally speaking, this rate was formed by adding to the effective rate an “equalization price” for balancing export and import profits and losses, and was applied to all national enterprises and corporations engaging in trade. It was also applied to receipts and expenditures in foreign exchange for trade-related transactions in invisibles, such as shipping and insurance. The trading business was done under an experimental trading system for foreign exchange, which was established by the Bank of China in a few areas, such as Beijing, Guangdong, Hefei, Shanghai, and Tianjin. National enterprises holding foreign exchange earned through the system of retention quotas were permitted to sell it to other national enterprises that had a quota for spending foreign exchange. For dealings under the foreign exchange retention scheme, the Bank of China acted as a broker, charging 0.1–0.3 per cent. This indicates that the market mechanism was introduced into the exchange rate forming process, and a breakthrough was made in the reform of the exchange rate mechanism. On 1 January 1985, the trade-related internal settlement exchange rate was abolished and the effective rate came to govern all trade, but a foreign exchange retention quota remained for a portion of export proceeds. On 20 November 1985, authorization was granted for Chinese residents to hold foreign exchange, to open foreign exchange accounts, and to deposit and withdraw funds in foreign currency. In November 1986, a foreign exchange swap rate was created, based on rates essentially agreed to between buyers and sellers. This became available for foreign investment corporations at over 100 foreign exchange adjustment centers and for Chinese enterprises in the four Special Economic Zones (Shantou, Shenzhen, Xiamen, and Zhuhai) initially, and then in 1988 it was expanded to all domestic entities authorized to retain foreign exchange earnings (World Currency Yearbook 1988–1989). The swap rate and official rate coexisted until the single rate regime was established in 1994. The transition period of 1985–1993 had two features. First, in accordance with the above statement, the renminbi had two prices vis-à-vis foreign currencies. The official price of the USD was lower than the swap rate, implying that the renminbi was set artificially high. The official rate was basically determined by the exchange cost of export goods plus a certain amount of profit. This is actually a practical application of a theory called tradable goods purchase power parity (Yang Fan, 1999)—a variant of purchase power parity. Second, the overvaluation of the renminbi made the currency face depreciation pressure, and indeed it followed a path of depreciation. While the official exchange rate and swap market exchange rate were approaching one another before 1992, the economic overheating driven by Deng Xiaoping’s South China Tour speeded up the renminbi depreciation process and widened the difference between the official rate and swap market rate. Simultaneously, the market exchange rate overshot and the renminbi was severely undervalued, as will be shown in an empirical study below. The integration of the dual exchange rate system in 1994 can be viewed as a continuing effort toward the
marketization of the financial market following the price reform in the goods market in 1988 The degree of overvaluation of the renminbi was not only reflected in the comparison of the official rate with the swap rate, but was also reflected in the black market. In 1982,one Hong Kong dollar could be exchanged for 0.38 yuan, a figure about 35 per cent higher than the official rate. In 1984, one hK dollar was equivalent to 0.8 yuan, more than double the official rate. According to an investigation carried out by the Shenzhen subsidiary of the PBOC, more than 60 enterprises were involved in the black dealings, with trad ing volume at USD148 million, or about 55.8 per cent of the total exports of Shenzhen The pressure of excessive demand for foreign currencies and the overvaluation of the renminbi resulted in a long-term depreciation trend of the renminbi. By the end of 1993 the official exchange rate had had fallen to 5.80 yuan per USD, 73 per cent from the 1.58 yuan per USD in early 1979 From the viewpoint of balance of payments, if the capital flow is rigorously controlled, the exchange rate fluctuation should reflect the current account or foreign exchange reserve fluctuation. When an economy faces a trade deficit increase or trade surplus decrease, its currency will face pressure toward depreciation. For example, when the high economic growth and opening-up accelerated in the PrC in 1980, 1985 and 1989, the renminbi experienced drastic depreciations The first big depreciation appeared in 1981 and 1982, when the renminbi depreciated by 13 and 10 per cent respectively. A strategy of constructing special economic zones was launched in 1984, leading to high economic growth, and the demand for foreign currencie and imports was so strong that the foreign exchange reserve fell from USD 13. 8 billion in August 1985 to USD2.6 billion at the end of 1985, and the trade surplus from USD2 billion in 1983 to USDo 014 billion in 1984. Since then the trade balance was in continuous deficit until 1989. Accordingly, the renminbi was depreciated successively in 1984, 1985 and 1986, from 1.98 yuan per USD in 1983 to 3. 72 yuan in 1986, representing a drop of 47 per cent. During 1988 to 1989, signs of overheating appeared in the economy, while the exchange rate of the renminbi had fallen to 5.32 yuan per USo A. by the end of 1991,the trade deficit remained and the renminbi was depreciated agai Thanks to Deng Xiaopings famous South China Tour in 1992, the pace of economic reform and opening up of the market to the outside world accelerated. Meanwhile, this led the economy to overheat once again(Kanamori and Zhao, 2005 ) One indication of this is that the inflation rate of consumer prices rose sharply by over 20 per cent, and a $10.6 billion trade deficit appeared in the balance of payments. This led to another cycle of depreciation of the renminbi To accord with the development of trade and opening up policy, the PRC abandoned its long-lasting policy of artificially overvaluing the renminbi and decided to introduce a market-based exchange rate regime. As a result, the swap market exchange rate and official rate were integrated. Eventually, the dual track system was terminated and market-based managed floating system was adopted
marketization of the financial market following the price reform in the goods market in 1988. The degree of overvaluation of the renminbi was not only reflected in the comparison of the official rate with the swap rate, but was also reflected in the black market. In 1982, one Hong Kong dollar could be exchanged for 0.38 yuan, a figure about 35 per cent higher than the official rate. In 1984, one HK dollar was equivalent to 0.8 yuan, more than double the official rate. According to an investigation carried out by the Shenzhen subsidiary of the PBOC, more than 60 enterprises were involved in the black dealings, with trading volume at USD148 million, or about 55.8 per cent of the total exports of Shenzhen. The pressure of excessive demand for foreign currencies and the overvaluation of the renminbi resulted in a long-term depreciation trend of the renminbi. By the end of 1993, the official exchange rate had had fallen to 5.80 yuan per USD, 73 per cent down from the 1.58 yuan per USD in early 1979. From the viewpoint of balance of payments, if the capital flow is rigorously controlled, the exchange rate fluctuation should reflect the current account or foreign exchange reserve fluctuation. When an economy faces a trade deficit increase or trade surplus decrease, its currency will face pressure toward depreciation. For example, when the high economic growth and opening-up accelerated in the PRC in 1980, 1985 and 1989, the renminbi experienced drastic depreciations. The first big depreciation appeared in 1981 and 1982, when the renminbi depreciated by 13 and 10 per cent respectively. A strategy of constructing special economic zones was launched in 1984, leading to high economic growth, and the demand for foreign currencies and imports was so strong that the foreign exchange reserve fell from USD13.8 billion in August 1985 to USD2.6 billion at the end of 1985, and the trade surplus from USD2 billion in 1983 to USD0.014 billion in 1984. Since then, the trade balance was in continuous deficit until 1989. Accordingly, the renminbi was depreciated successively in 1984, 1985 and 1986, from 1.98 yuan per USD in 1983 to 3.72 yuan in 1986, representing a drop of 47 per cent. During 1988 to 1989, signs of overheating appeared in the economy, while the trade deficit remained and the renminbi was depreciated again. By the end of 1991, the exchange rate of the renminbi had fallen to 5.32 yuan per USD. Thanks to Deng Xiaoping’s famous South China Tour in 1992, the pace of economic reform and opening up of the market to the outside world accelerated. Meanwhile, this led the economy to overheat once again (Kanamori and Zhao, 2005). One indication of this is that the inflation rate of consumer prices rose sharply by over 20 per cent, and a $10.6 billion trade deficit appeared in the balance of payments. This led to another cycle of depreciation of the renminbi. To accord with the development of trade and opening up policy, the PRC abandoned its long-lasting policy of artificially overvaluing the renminbi and decided to introduce a market-based exchange rate regime. As a result, the swap market exchange rate and official rate were integrated. Eventually, the dual track system was terminated and a market-based managed floating system was adopted
From the launch of the reform and opening up policy in 1978 to the integration of the exchange rate regime in 1994, the average renminbi exchange rate against major trad ing partners both in terms of the nominal and real effective exchange rates fluctuated greatly, by 68 per cent and 76 per cent, respectively. However, this depreciation process was not basically completed until the breakout of the 1997 Asia crisis The most important message here seems to be that the official rate was politically determined and tended to be overvalued. However, this overvaluation, under an imperfect market, is only meaningful relative to the swap market exchange rate, and not to the fund amental factor-based exchange rate(see Chapter 5). Clearly, the politics behind the overvaluation must be that the government benefited from the overvaluation under the traditional system in the sense that foreign exchange revenue was forcibly sold to the PBOC. The overvaluation of the renminbi meant that the government could buy foreign exchange at a lower price. In other words, the central government was able to get extra tax" by overvaluing the renminbi However, taking a realistic account of the international competitiveness of the PRC economy, the trade related real exchange rate had to be set at a very low level to promote exports. Accordingly the depreciation pressure on the official rate was intensified. This shows that there was a contradiction between foreign trade development and exchange rate policy in the traditional system, which was not very easy to resolve 2 Integration of the exchange rate regime On 1 January 1994, the Pboc announced a reference rate for the renminbi against the USD, the Hong Kong dollar, and the Japanese yen based on the weighted average price of foreign exchange transactions of the previous day's trading, marking a new stage for the exchange rate regime. In accordance with the announcement, daily movements of the exchange rate of the renminbi against the USD were limited to 0.3 per cent on either side of the reference rate announced by the PboC. the buying and selling rates of the renminbi against the Hong Kong dollar and the Japanese yen were not permitted to deviate from more than l per cent on either side of the reference rate, in the case of other currencies, the deviations should not exceed 0.5 per cent on either side of their respective reference rates (IMF1997,p.196) When the renminbi exchange rate and foreign exchange swap market rate were integrated the official rate was 5. 8 and swap market rate 8.6. The integration of exchange rate made the official exchange rate depreciated by 33. 3 per cent. Taking account of the fact that 80 per cent of forex transactions at the time were done in the swap market, the real devaluation of the currency was 6.7 per cent. To elaborate the situation of exchange rate fluctuations after 1994, we divide this period into three different sub-phases the period of transition after integration from 1994 to 1997; the period of depreciation pressure after the Southeast Asian crisis from 1998-2001 and the period of appreciation pressure afterwards The unified exchange rate terminated the long-standing situation of the renminbi overvaluation and, thereby, reversed a persistent trend of decline. From 1994 to the end of
From the launch of the reform and opening up policy in 1978 to the integration of the exchange rate regime in 1994, the average renminbi exchange rate against major trading partners both in terms of the nominal and real effective exchange rates fluctuated greatly, by 68 per cent and 76 per cent, respectively. However, this depreciation process was not basically completed until the breakout of the 1997 Asia crisis. The most important message here seems to be that the official rate was politically determined and tended to be overvalued. However, this overvaluation, under an imperfect market, is only meaningful relative to the swap market exchange rate, and not to the fundamental factor-based exchange rate (see Chapter 5). Clearly, the politics behind the overvaluation must be that the government benefited from the overvaluation under the traditional system in the sense that foreign exchange revenue was forcibly sold to the PBOC. The overvaluation of the renminbi meant that the government could buy foreign exchange at a lower price. In other words, the central government was able to get extra “tax” by overvaluing the renminbi. However, taking a realistic account of the international competitiveness of the PRC economy, the trade related real exchange rate had to be set at a very low level to promote exports. Accordingly the depreciation pressure on the official rate was intensified . This shows that there was a contradiction between foreign trade development and exchange rate policy in the traditional system, which was not very easy to resolve. 2 Integration of the Exchange Rate Regime On 1 January 1994, the PBOC announced a reference rate for the renminbi against the USD, the Hong Kong dollar, and the Japanese yen based on the weighted average price of foreign exchange transactions of the previous day’s trading, marking a new stage for the exchange rate regime. In accordance with the announcement, daily movements of the exchange rate of the renminbi against the USD were limited to 0.3 per cent on either side of the reference rate announced by the PBOC. The buying and selling rates of the renminbi against the Hong Kong dollar and the Japanese yen were not permitted to deviate from more than 1 per cent on either side of the reference rate; in the case of other currencies, the deviations should not exceed 0.5 per cent on either side of their respective reference rates (IMF 1997, p.196). When the renminbi exchange rate and foreign exchange swap market rate were integrated, the official rate was 5.8 and swap market rate 8.6. The integration of exchange rate made the official exchange rate depreciated by 33.3 per cent. Taking account of the fact that 80 per cent of forex transactions at the time were done in the swap market, the real devaluation of the currency was 6.7 per cent. To elaborate the situation of exchange rate fluctuations after 1994, we divide this period into three different sub-phases: the period of transition after integration from 1994 to 1997; the period of depreciation pressure after the Southeast Asian crisis from 1998–2001 and the period of appreciation pressure afterwards. The unified exchange rate terminated the long-standing situation of the renminbi overvaluation and, thereby, reversed a persistent trend of decline. From 1994 to the end of
1997, the renminbi's nominal exchange rate against the USD appreciated by 4.8 per cent, up to 8.2. Taking into account the rapid increase in domestic prices in the period from 1994 to 1995, the real appreciation of the renminbi against the USD was 39 per cent. Meanwhile the renminbi's nominal and real effective exchange rates rose by 10.9 per cent and 30.2 per cent, respectively(IMF, IFS database 2004) The appreciation of the renminbi during the period from 1994 to 1997 once again led to the expectation of a devaluation. This expectation was further intensified by the Southeast Asia financial crisis of 1998, which incurred a wave of capital flight. To prevent the crisis from spread ing further, the PRc government made a commitment to not devalue the renminbi, keeping it at 8.28 yuan per USD and taking other measures to offset the external shocks to exports, including, for example, export tax refunds. This was recognized as a significant contribution by the prc to the economic and financial stability of Asia and the world Since the prc did not devalue the renminbi while most of the other currencies weakened against the USD from 1997 to 2001, the renminbi became one of a few strong currencies in emerging markets. Its nominal and real effective exchange rates rose by 10.9 per cent and 5.5 per cent, respectively It must be recognized, however, that the commitment to not devalue the renminbi was not without costs. In fact, one of the costs that the PRC had to bear was deflation. To get rid of the deflation, the PRC had to adopt a five-year proactive fiscal policy, which resulted in a considerable fiscal deficit. Of course, perhaps thanks to the deflation, which finally strengthened the competitive power of Chinese products, as well as to the proactive fiscal policy, which improved the social infrastructure and investment environment, the PrC economy enjoyed economic prosperity in recent years deflationary Press hary achievements were made under the nation's efforts to tackle Shortly aft sures came the external shocks from the terrorist attacks of 11 September 2001 and the outbreak of the SArs(severe acute respiratory syndrome)epidemic in the PRC and other Asian countries, and the world economy slowed down. The PRC maintained consistency in its exchange rate policy and continued to keep the renminbi exchange rate within a relatively narrow range(Guo Shuqing, 2004) Since it was still pegged to USD after 2002, the renminbi exchange rate weakened along with the USD. by the end of 2003, the exchange rate of the euro had risen by 36 per cent and the Canadian dollar, British Pound, Japanese yen and Korean won by 19 per cent, 17 per cent, 14 per cent and 11 per cent respectively, while the Mexican peso fell by 14 per cent and the brazilian real by 17 per cent( David Wessel 2003). Accordingly, nominal and real effective exchange rates of the renminbi vis-a-vis other foreign currencies fell by 9. 3 per cent and 11.0 per cent, respectively. Taking account of the real appreciation of the renminbi between 1998 and 2001. this means the effective exchange rates both in nominal and real terms remain approximately at the level of 1998 In summary, the renminbi's nominal exchange rate was basically in a downward trend before 1994. when the exchange rate integration was achieved. but afterwards. it became
1997, the renminbi’s nominal exchange rate against the USD appreciated by 4.8 per cent, up to 8.2. Taking into account the rapid increase in domestic prices in the period from 1994 to 1995, the real appreciation of the renminbi against the USD was 39 per cent. Meanwhile, the renminbi’s nominal and real effective exchange rates rose by 10.9 per cent and 30.2 per cent, respectively (IMF, IFS database 2004). The appreciation of the renminbi during the period from 1994 to 1997 once again led to the expectation of a devaluation. This expectation was further intensified by the Southeast Asia financial crisis of 1998, which incurred a wave of capital flight. To prevent the crisis from spreading further, the PRC government made a commitment to not devalue the renminbi, keeping it at 8.28 yuan per USD and taking other measures to offset the external shocks to exports, including, for example, export tax refunds. This was recognized as a significant contribution by the PRC to the economic and financial stability of Asia and the world. Since the PRC did not devalue the renminbi while most of the other currencies weakened against the USD from 1997 to 2001, the renminbi became one of a few strong currencies in emerging markets. Its nominal and real effective exchange rates rose by 10.9 per cent and 5.5 per cent, respectively. It must be recognized, however, that the commitment to not devalue the renminbi was not without costs. In fact, one of the costs that the PRC had to bear was deflation. To get rid of the deflation, the PRC had to adopt a five-year proactive fiscal policy, which resulted in a considerable fiscal deficit. Of course, perhaps thanks to the deflation, which finally strengthened the competitive power of Chinese products, as well as to the proactive fiscal policy, which improved the social infrastructure and investment environment, the PRC economy enjoyed economic prosperity in recent years. Shortly after primary achievements were made under the nation’s efforts to tackle deflationary pressures came the external shocks from the terrorist attacks of 11 September 2001 and the outbreak of the SARS (severe acute respiratory syndrome) epidemic in the PRC and other Asian countries, and the world economy slowed down. The PRC maintained consistency in its exchange rate policy and continued to keep the renminbi exchange rate within a relatively narrow range (Guo Shuqing, 2004). Since it was still pegged to USD after 2002, the renminbi exchange rate weakened along with the USD. By the end of 2003, the exchange rate of the euro had risen by 36 per cent, and the Canadian dollar, British Pound, Japanese yen and Korean won by 19 per cent, 17 per cent, 14 per cent and 11 per cent respectively, while the Mexican peso fell by 14 per cent and the Brazilian real by 17 per cent (David Wessel 2003). Accordingly, nominal and real effective exchange rates of the renminbi vis-a-vis other foreign currencies fell by 9.3 per cent and 11.0 per cent, respectively. Taking account of the real appreciation of the renminbi between 1998 and 2001, this means the effective exchange rates both in nominal and real terms remain approximately at the level of 1998. In summary, the renminbi’s nominal exchange rate was basically in a downward trend before 1994, when the exchange rate integration was achieved, but afterwards, it became
relatively stable and floated within a narrow band. However, the USD-pegged system forced price adjustments domestically in different directions, which made the exchange rate in real term still fluctuate with the USd to some degree From 1994 to 2003, the nominal and real effective exchange rates of the renminbi vis-a-vis other currencies as a whole rose by 6.7 per cent and 31.5 per cent In nominal terms, the currency strengthened by 5. 1 per cent and 10.3 per cent against the USD and the Japanese yen, respectively, while the real appreciation was 20. 1 per cent and 59.1 per cent considering inflation differentials( Guo Shuqing, 2004) 3 A Few Findings from the evolution of the Exchange rate regime From the above fact, we find that the PRC's exchange rate sy stem evolved with the reform and opening up policy, and the renminbi exchange rate was driven by pressures from the market as well as by external factors Before the integration of the official rate and swap rate, the renminbi exchange rate was gradually driven downward by the excessive demand for foreign currencies. It is clear that every sharp adjustment of the exchange rate coincides with extensive reform and opening up policies, which led to high economic growth, high inflation and the trade imbalance After the departure from the dual track exchange rate system, the nominal exchange rate remained relatively stable, but the real exchange rate floated upward and downward at a surprising pace compared to the PrC's trad ing partners. Through changes in relative prices between the PRC and the rest of the world the renminbi's average exchange rate experienced enormous fluctuations. It appreciated by more than 20 per cent in the last 10 years, or nearly 60 per cent if inflation is taken into account The response of the exchange rate to the market supply and demand is asymmetric. For example, before the unification of the exchange rate in 1994, the demand for foreign currencies put lasting downward pressure on the renminbi. This was because the demand for foreign currencies was high but the central bank could not satisfy it, leading the price of foreign currencies to rise. However, when the supply of foreign currencies exceeded the demand, the central government was able to absorb excessive foreign currencies by printing paper money if it wished to do so and was ready to take the inflation risk. The derlying factor behind this asymmetry is that the government has full authority to issue domestic currency but no right to issue foreign currency
relatively stable and floated within a narrow band. However, the USD-pegged system forced price adjustments domestically in different directions, which made the exchange rate in real term still fluctuate with the USD to some degree. From 1994 to 2003, the nominal and real effective exchange rates of the renminbi vis-a-vis other currencies as a whole rose by 6.7 per cent and 31.5 per cent. In nominal terms, the currency strengthened by 5.1 per cent and 10.3 per cent against the USD and the Japanese yen, respectively, while the real appreciation was 20.1 per cent and 59.1 per cent considering inflation differentials (Guo Shuqing, 2004). 3 A Few Findings from the Evolution of the Exchange Rate Regime From the above fact, we find that the PRC’s exchange rate system evolved with the reform and opening up policy, and the renminbi exchange rate was driven by pressures from the market as well as by external factors. Before the integration of the official rate and swap rate, the renminbi exchange rate was gradually driven downward by the excessive demand for foreign currencies. It is clear that every sharp adjustment of the exchange rate coincides with extensive reform and opening up policies, which led to high economic growth, high inflation and the trade imbalance. After the departure from the dual track exchange rate system, the nominal exchange rate remained relatively stable, but the real exchange rate floated upward and downward at a surprising pace compared to the PRC’s trading partners. Through changes in relative prices between the PRC and the rest of the world, the renminbi’s average exchange rate experienced enormous fluctuations. It appreciated by more than 20 per cent in the last 10 years, or nearly 60 per cent if inflation is taken into account. The response of the exchange rate to the market supply and demand is asymmetric. For example, before the unification of the exchange rate in 1994, the demand for foreign currencies put lasting downward pressure on the renminbi. This was because the demand for foreign currencies was high but the central bank could not satisfy it, leading the price of foreign currencies to rise. However, when the supply of foreign currencies exceeded the demand, the central government was able to absorb excessive foreign currencies by printing paper money if it wished to do so and was ready to take the inflation risk. The underlying factor behind this asymmetry is that the government has full authority to issue domestic currency but no right to issue foreign currency
