RMB CONVERTIBILITY AND FX MARKET CONSTRUCTION AMID GLOBALIZATION

Since the 1980s, "deregulation" in the financial sector, driven by the progress of science and information technology, has become a buzzword, as many countries are eager to join the trend of economic globalization. More market-oriented policy measures have been adopted to promote capital account convertibility of domestic currencies and establish a more flexible exchange rate policy framework characterized by a floating exchange rate regime. This process, however, witnessed the subsequent economic crises in Latin American and Asian countries. Some countries were even afflicted with certain degree of economic upheavals whose aftermath can still be felt today. But it is undeniable that the trend of economic globalization is irreversible and the process of financial liberalization continuous with the ever-emerging financial innovations. Countries worldwide can find an exchange rate regime and financial system geared to their current phases of economic development through establishing a negotiating and consulting mechanism. Undoubtedly, this process will contribute to the balanced and sustainable development of the global economy.

China's gradual and effective reforms of its FX administration and exchange rate regime started as early as in the mid-1980s. Since then a single, managed floating exchange rate regime has been formed on the basis of RMB current account convertibility. While these reform measures were being taken, China managed to maintain the overall stability of RMB exchange rate and safeguard its domestic economy against the adverse impacts of the Asian financial crisis and global economic recession. This is in the best interests of not only China but also the surrounding countries and the whole world.

With the deepening of economic globalization, China, in light of its current economic development, still has a long way to go towards the full convertibility of RMB, a process that should be done both voluntarily and gradually. At present, China has realized partial convertibility of RMB under capital account. The next step of the reform aims at achieving fundamental convertibility under capital account. Next, then, is the full convertibility done by lifting capital account controls selectively and then gradually taking into consideration the objective demands of economic development as well as reform and opening up. However, how to handle the sequence of and coordinate the relationship between RMB convertibility and the reforms to improve RMB exchange rate forming mechanism is of great significance to the success of the reform and China's stable and sustainable economic growth. In my opinion, in the process of realizing RMB convertibility through the gradual relaxation of capital account control, it seems more important and pressing to accelerate the construction of the FX market, to perfect the functions of the FX market and to rectify the market forming mechanisms of the RMB exchange rate.

A country may have many alternatives concerning the convertibility of its currency and the exchange rate regime to adopt. That is to say that a currency can be freely convertible under either a fixed exchange rate regime or floating exchange rate regime. Next, the free convertibility of a currency and the choice of exchange rate regime can be differently sequenced. Free convertibility can be realized before the exchange rate regime is chosen; or the exchange rate regime can be set before moving towards the gradual realization of full convertibility. What's feasible for China, I think, is to gradually relax capital account controls and ultimately realize the full free convertibility of RMB via the formation of a market-oriented RMB exchange rate mechanism on the basis of the current RMB current account convertibility and partial capital account convertibility. This approach will not only benefit China's sustainable economic development by riding out the ups and downs in the financial market, but will also facilitate the steady process towards RMB capital account convertibility, thus doing good to China's economy as well as the global economy.

Then, how can we accelerate the RMB convertibility process through the harmonious development of the FX market? I believe that for the present and the near future we should give top priority to the market forming mechanism of the RMB exchange rate and approach the issue from the following aspects:

Firstly, steadily advance the reform of FX administration system and establish a discretional FX sale and purchase mechanism. With the current FX administration system, the sale and purchase of FX by enterprises and banks is not market driven, leaving the RMB exchange rate risk totally to the country, especially when there are speculations on the appreciation or depreciation of RMB. By establishing the discretional FX sale and purchase mechanism, banks or enterprises themselves can choose to sell or buy foreign exchange based on their business operations, thus making the rate fully reflect market demand and supply and laying the foundation for the market forming mechanism of RMB exchange rate. This discretional FX sale and purchase mechanism is not likely to cause much turmoil in the FX market before a fully opened capital account is in place.

Secondly, give full play to FX reserve's adjustment function in the RMB exchange rate forming mechanism. Under the discretional FX sale and purchase mechanism, authorities may moderately relax the fluctuation range of RMB exchange rate and encourage banks to be market makers in the FX market by gradually allowing them to make two-way quotes, ultimately forming the RMB exchange rate transmission mechanism. The central bank may consider intervention using FX reserves in line with the goal of macro policy and the situation in the FX market, adjusting the market equilibrium level of the exchange rate and therefore warding off negative impacts of violent exchange rate fluctuation on the macro-economy.

Finally, enrich FX market products and perfect market functions as quickly as possible. Objectively speaking, the current FX market can merely satisfy customers' basic needs for clearing and settlement with its risk hedging function far underdeveloped. With the advancing of RMB interest rate liberalization, innovations are urgently needed in launching more RMB exchange rate and interest rate related products such as forward, options, and interest rate swaps. With the introduction of these RMB interest rate and exchange rate risk management products, the functions of China's FX market can be substantially enhanced, while the clearing and settlement demands of the customers better satisfied.