Governor Zhou Xiaochuan
Speaks on Issues Related to the Reform of the Exchange Rate Regime
The
Central Bank Round Table was held in Canada
on September 9, 2005. Governor Zhou Xiaochuan
of the People´s Bank of China was invited to speak at the meeting and answered
questions from the audience and the press. In an interview with the Financial
News (Chinese), Governor Zhou answered questions concerning the discussions at the
meeting.
1.
On July 21, 2005, the
People's Bank of China
made an announcement on the reform of the RMB exchange rate regime. That was
really a surprise to the market at that time. Could you give some details about
the decision process and timing of the reform?
All
the decisions adopted by the Chinese government in the process of the pro-market
economic reform have been centered on the central target which is to establish
a socialist market economy in China. The
exchange rate regime should be consistent with the market economic system in
which the currency should be convertible with its price being able to reflect
the relationship between supply and demand so as to meet requirements of a
market economy with a relatively high degree of openness, and the exchange rate
should be allowed to float. According to the general goals of the reform of the
exchange rate regime set at the Third Plenary Session of the Sixteenth CPC
National Congress in 2003, China will seek
to establish and improve the managed floating exchange rate regime based on
market supply and demand to keep the RMB exchange rate basically stable at an
adaptive and equilibrium level. Efforts will also be made to gradually realize
RMB convertibility under capital account by lifting the restrictions on
cross-border capital movements in a selective and step-by-step manner while
effectively controlling the risks. Broad consensus was reached on the sequence
of exchange rate reform and other financial reforms. Progress has to be
achieved in the following areas before reforming the RMB exchange rate regime.
First, banking reform has made headway and the banking system has been
strengthened. Second, steps have been taken to remove the unwarranted controls
on foreign exchange transactions, including those on certain capital account
transactions. Third, with deepened development of the foreign exchange market,
domestic financial institutions and importers and exporters have been able to
operate in more favorable market environment and with more risk-hedging
instruments.
To
achieve the above goals, China has made
tremendous efforts and has achieved concrete progress. In late 2003, measures
of financial restructuring, including capital replenishment, writing-off of
non-performing assets and joint-stock transformation, was conducted in the Bank
of China and the China Construction Bank. Financial restructuring was also
carried out in the Industrial and Commercial Bank of China
in the first half of this year. Up to now, three of the four state-owned
commercial banks have undergone financial restructuring and have implemented
join-stock reform measures. The reform of the 30,000 rural credit cooperatives
were also launched in 2003, and more than half of the work has been completed.
Active efforts have been made in pushing ahead with the reform of the other
financial institutions. Of course, banking reform will take a long period of
time, and we cannot wait to start reforming the exchange rate regime until all
banking reform measures have been completed. But most of the reform measures
should have been put in place. China's
commercial banking system is composed of four levels, namely, the wholly
state-owned commercial banks, joint-stock commercial banks, city commercial
banks, and rural banking institutions. 70 to 80 percent of each level have
basically completed reform and restructuring and have entered into a favorable
development stage.
In
addition, some unwarranted controls over capital account transactions have been
removed; the capital market has become increasingly open to the outside world;
restrictions on the current account transactions by the individuals and
enterprises have been relaxed; market entry and business scope have been
further expanded; and improvement of financial market infrastructure has laid a
sound foundation for the reform of the exchange rate regime.
Macroeconomic
environment is also conductive to the exchange rate reform. The national
economy has maintained steady and fast growth; the excessively rapid growth of
investment has been contained; the increase of CPI is moderate; the global
economic performance is stable, with the interest rate of the US dollar rising
steadily, which is also an important condition for the reform of the RMB
exchange rate regime. Against such a backdrop and with very carefully
consideration, the Chinese government decided to carry out the reform of the
RMB exchange rate regime.
We
have noticed that since April this year, when necessary conditions for the RMB
exchange rate reform have gradually been met, some "noises" have
emerged. For example, the Schumer and Graham Bill exerted pressures on China by threatening to taken trade protectionism
measures against China. Such
"noises" will not change the basic conditions and sequence of China's exchange rate reform, but only to disturb
the normal course of the reform.
Some
people speculated that the reform of RMB exchange rate regime was conducted
under external pressures. In fact, the Chinese government has always been
adopting an independent and highly responsible attitude on the issue of RMB
exchange rate. We will proceed from the fundamental interest and economic and
social realities of China, and
adopt the exchange rate regime and exchange rate policies that are suitable to China's specific conditions.
2.
What are the principles and motives for the reform of the RMB exchange rate
regime?
The
reform of the RMB exchange rate regime must proceed in a proactive,
controllable and gradual way. "Proactive" means the reform mode,
contents and timing must be based on the needs arising in the process of China's domestic reform and development. The impact
of exchange rate regime reform on macroeconomic stability, economic growth and
employment must be taken into account. "Controllable "implies that we
must be able to control the changes brought by the reform of the RMB exchange
rate regime at the macro level so that the reform momentum could progress
steadily to avoid large fluctuations of the financial markets and the economy.
"Gradual" means the reform of the exchange rate regime must be
carried forward in a gradual manner to ensure sufficient resilience of all the
parties involved.
Reforming
the RMB exchange rate regime is a requirement for establishing and
strengthening the socialist market economic system in China,
it also represents an important component of the overall program to deepen the
economic system reform and improve the macroeconomic adjustment mechanism. It
is consistent with the requirements put forward by the central government
regarding establishing a managed floating exchange rate regime based on market
supply and demand and further improving the RMB exchange rate system so as to
maintain the RMB exchange rate basically stable at an adaptive and equilibrium
level. It also fits in with the fundamental and long-term interests of the
country, reflects the objective requirement of implementing a scientific
approach to economic development and holds great significance for promoting a
comprehensive, coordinated and sustained development of the economy and
society. Reforming the RMB exchange rate regime is also needed to ease external
trade imbalance, boost domestic demand, strengthen competitiveness of the
Chinese enterprises and upgrade the level of economic opening up. We do not
intentionally seek a trade surplus, nor a growth of foreign reserves. What we
intend to achieve is a basic equilibrium in the balance of payments, in
particular the basic equilibrium in the trade of goods and services. The
revaluation of the RMB by 2 percent was effected based on the size of China's trade surplus and the need to implement
foreign trade restructuring, while at the same time taking into account the
adaptability of the domestic enterprises.
An
important goal of the exchange rate reform in China
is to achieve an enhanced equilibrium of the balance of international payments
through changes in relative prices, so as to provide more sustained support to
the long-term growth of the economy. In China's
case, the equilibrium of balance of payments should emphasize more on the
general equilibrium of trade both in goods and services. Between 2000 and 2004,
trade in goods and services was generally in balance, with the goods trade
recording a surplus of US$20-30 billion and the service trade displaying a
deficit of about US$10 billon. The combined value amounted to about 2 percent
of China's GDP and the total trade respectively
(larger numbers may be witnessed this year due to some special reasons). If
added with other two items of the current account (proceeds and current
transfer), the surplus recorded under current account could rise to about 4.1
percent of the GDP last year. However, proceeds and current transfer are not as
stable as the trade in goods and services. On the one hand, they tend to move
with changes in currency appreciation expectations. For example, when
expectations on currency appreciation rise, dividend distribution under the
item of proceeds may be reduced so that the enterprises could keep the
undistributed profits to benefit from a revalued currency. Apart from that,
when currency appreciation expectations build up, inward overseas remittance
may increase fast. On the other hand, the two types of transactions can be
easily mixed with transactions under capital account. In our view, statistics
may also need to improve. For example, we could consider establishing a revised
current account composed mainly of transactions of trade in goods and services.
Based on these considerations, we hope the exchange rate adjustment in this
reform could be rational enough to achieve a balance (more or less) of the
trade in goods and services. Of course, we cannot guarantee the calculations
100 percent accurate, and tolerable errors should be allowed. We also hope
these errors could be finally corrected with the functioning of the relative
price mechanism.
3.
What are the features of the new RMB exchange rate regime?
After
the reform, the RMB was no longer pegged to the US dollar. Instead, the RMB
exchange rate would be determined based on a basket of certain major currencies
selected with assigned weights in line with the real situation of China's external economic development. At the same
time, proper measures could be taken to manage and adjust the RMB exchange rate
based on market supply and demand while considering the changes of the basket
currencies, so as to maintain the RMB exchange rate basically stable at an
adaptive and equilibrium level. Reference to a basket of currencies indicates
that the RMB exchange rate could be affected by the exchange rate changes
between the foreign currencies, but not necessarily a peg of RMB to the basket
currencies. The managed floating exchange rate regime must also be based on
another important factor which is the situation of market supply and demand.
4.
Why don't you directly adopt a freely floating exchange rate regime? What is
the role of the central bank in the new exchange rate system?
China's exchange rate regime after the reform is
still a managed floating system. Why don't we adopt a more radical approach by
moving into a freely floating exchange rate regime, as proposed by some people?
First of all, the preconditions for adopting a freely floating exchange rate
regime have not yet been met. Against the backdrop of global economic
imbalances and uncertainties as well as large amount of cross-border capital
flows, China has not prepared well to
cope with sharp and disorderly adjustment of the world economy. Moreover, with
regard to the reform philosophy, while stressing the fundamental role of the
market in resource allocation, China also
attaches great importance to the government's regulatory role at the macro level.
The managed floating exchange rate regime has been adopted under such a reform
strategy.
The
main role of the central bank in a managed floating exchange rate regime is to
act as a filter, doing nothing with the normal fluctuations, but smoothing out
the abnormal movements including excessively large or too frequent changes.
Such a role of the central bank is adaptive in nature, and may be reduced over
time, as the economy gets more resilient to shocks. On the other hand, the
central bank should stand ready to prevent crisis. Should any emergencies
arise, such as the outbreak of wars, natural disasters or financial crises, the
central bank may take special actions to intervene in the market. The managed
floating exchange rate regime has been designed to allow the central bank to
perform such a function.
5.
How will the exchange rate adjustment affect China's
balance of payments?
Large
economies are different from the small ones. Although the exchange rate is a
useful instrument in the adjustment of balance of payments, it is equally
important to stress the role of domestic demand in improving the balance of
payments. It is true that exchange rate plays a role in promoting balance of
payments equilibrium and current account readjustment. Based on past
experiences and analysis of economic parameters and real effective exchange
rates, we can estimate the exchange rate elasticity of trade. Statistical
analysis shows that the role of exchange rate in adjusting the balance of
payments is significant. Nevertheless, for large economies, domestic demand may
be even more important. Domestic demand is only partially affected by changes
in relative prices. Some macroeconomic policies and structural policies, such
as the regulation of the housing market or the special policies for certain
industries, will have an impact on domestic demand. It is obviously not
desirable to rely solely on the exchange rate to promote the balance of
payments equilibrium without adjusting the macroeconomic and structural
policies. In China, price rigidities could be
observed with the following four aspects. The first is demographic trend. Big
changes are expected in China's
demographic development in the coming two or three decades, which will not be
significantly affected by price movements. In addition, changes in the
dependency ratio will affect the savings rate, and changes in the proportion of
different generations in total population will lead to changes in both the
aggregate amount and structure of consumption. The second is cultural
traditions. Some scholars say that the Asian countries including China have a tradition to save. The third is social
security system. The process of reforming the pension, health care and
unemployment insurance systems has resulted in uncertainties and the need to
save among the public. We need to further clarify the goals of these reforms
and make stronger efforts to advance the reform process, so as to minimize the
uncertainties and strengthen consumers' confidence in the transition period.
The fourth is housing reform and education reform. People are not clear about
how much they will have to spend on the education of their children. The
housing reform in 1998 and 1999 may have produced wealth effect, but the
development of housing prices may also cause crowding-out effect on
consumption. The four aspects mentioned above are characterized by high price
rigidity or price stickiness, or the impact of price changes on them is
uncertain, requiring necessary adjustment of domestic economic policies. A similar
conclusion can be reached in analyzing the US
economy.
6.
How do you see the relationship between the RMB exchange rate, the Sino-US
trade imbalance and the global imbalance?
Current
account imbalance between China and the US has attracted much attention. The US reported its trade deficits with China larger than our customs statistics. The US figure includes imports of Chinese goods via
a third place, but excludes US exports to China
by indirect route. It also neglects surplus recorded by the US in service and royalty income from China. In our understanding and speaking from
relevant principles of the WTO and the economics, a country needs to consider
its overall trade balance with the rest of the world rather than only bilateral
trade with a particular country in the process of developing its economy. On
the other hand, as mentioned above, large economies are substantially different
from the small economies in that in the large economies, although relative
prices can take effect, factors affecting domestic demand like savings rate,
consumption, wealth effect and asset price are more important in deciding the
economic performance. As for China,
uncertainties associated with reforms in the areas of pension system, medical
system and education system will have an impact on the savings rate and
consumer confidence which could in turn influence domestic demand over a
certain period of time, and it takes some time to address these concerns
through reform measures.
Moreover,
we need to reflect upon the development strategy adopted by large economies.
After the 1950s, certain economies in Asia
successively adopted an export-oriented development strategy, which has led to
the rise of the so-called "four tigers" and "four dragons".
The IMF and World Bank once also encouraged large economies like China and India
to apply the export-oriented strategy in developing the economy. However, when
a large economy pursues export-oriented development strategy up to a certain
stage, its impact on the world economy will present a different challenge for
the whole world to cope with.
Broadly
speaking, efforts should be made to emphasize on multiple trade balance rather
than on the bilateral trade balance while at the same time taking into account
the impact of factors like domestic demand related polices and the choice of
development strategy. These factors play different roles and could be mutually
reinforcing with the exchange rate policy.
7.
By end of June this year, China's
foreign reserve has reached US$711 billion. Will the determination of the
basket currencies have an impact on the currency compositions of the foreign
reserves?
Some
people have expressed concerns about the correlations, if any, between the
considerations in the selection of basket currencies and that in deciding on
the composition of foreign reserves, after China
adopted the managed floating exchange rate regime based on market supply and
demand with reference to a basket of currencies. As a matter of fact, these two
issues are pondered separately in China
as the bases on which to build our considerations for the two issues are
different. Besides, China has taken
a responsible attitude and do not wish to see fluctuations in the world
financial market caused by our active composition adjustment of the foreign
reserves. We will not take any imprudent actions in this regard so as to
prevent from falling into a scapegoat for irresponsible actions committed by
others. As for the determination of basket currencies and their respective
weights, I have explained in Shanghai on August
10 that major considerations would be given to the shares of our trading
partners in China's trade in goods and
services. Generally speaking, the currencies of countries with which China registers an annual bilateral trade in excess
of US$10 billion are not negligible in weight assignment, at the same time
proper considerations are also given to the currency compositions of China's foreign debt, FDI as well as the unrequited
transfers under the current account.
8.
How do you explain the large accumulation of foreign exchange reserves by the
Asian countries, including china?
It
is a phenomenon related to the Asian financial crisis. After the crisis, most
Asian countries sought to significantly increase their foreign exchange
reserves, initially for the purposes of repaying external debt and making up
for the loss of reserves during the crisis, and later for the prevention of
risks. The international community has not yet established an effective way to
cope with the liquidity crisis of individual countries. Some people think that
the IMF should play a greater role by providing more transparent and
foreseeable liquidity support to countries anticipating liquidity problems.
Meanwhile, the IMF should strengthen the early warning systems against crisis.
With the IMF playing a more effective role in this area, every country may
reduce its holding of foreign exchange reserves.
This
issue is also related to the hedge funds. Some hedge funds have been engaged in
malicious speculative activities. Should the hedge funds be regulated? What are
the responsibilities of the international institutions in this regard? And
should those large and rich countries with relatively large number of hedge
funds consider establishing systems and mechanisms to regulate the hedge funds?
We Chinese people believe that there are two sides to everything. On the one
hand, we should not let regulation discourage innovation and reduce the
vitality of the economy. On the other hand, countries may increase their
holdings of foreign exchange reserves if they are concerned with the volatile
capi
