FINANCIAL MACRO ADJUSTMENT AND REFORM ON RMB EXCHANGE RATE MECHANISM

--- An interview with Zhou Xiaochuan, Governor of the PBC

Since last year problems have occurred in China's economy, for instance, over rapid growth in investment, undue expansion of money credit, intensifying pressure of inflation, and some bottleneck links affecting the economic stability. Regarding these problems, China has reinforced various monetary policies instruments to check the growth in money credit and step up macro adjustment on the economy. At present, these macro-adjustment approaches have taken initial effects, which are shown in the easing overgrowth in fixed asset investment and also in the fact that the money credit rise has leveled off to a reasonable level. However, the still big pressure of investment and the stress of inflation which is far from relaxed have determined that the macro adjustment is still at a crucial stage.

“Perfect RMB exchange rate forming mechanism, keep the basic stability of RMB at a reasonable and balanced level, relax restrictions on cross border capital trading in a optional and gradual manner on the premise of effectively warding off risks, and gradually realize RMB convertibility under capital account”. This is the set objective of China's reform on its exchange rate regime. First, to “perfect RMB exchange rate forming mechanism” means more flexibility; second, being “reasonable and balanced” shows that the exchange rate is decided by market demand and supply, so as to realize the general balance of international payments. The increase in current account surplus and FX reserves is not the objective China pursues. Third, to “gradually realize the convertibility of RMB under capital account” indicates that China is stepping toward an exchange rate regime more adapted to market economic system.

China had made great efforts in recent years to improve the RMB exchange rate forming mechanism in the following six aspects.

First, reform of commercial banks has been accelerated. Bank of China and China Construction Bank have basically finished their financial restructuring and transformed into joint stock corporations; the Bank of Communication has cooperated with strategic investors, making significant breakthroughs in joint stock reforms.

Second, some restrictions on capital account are being relaxed. The administration on domestic institutions' investment abroad becomes loose; domestic enterprises' direct investment abroad is further facilitated; considerations are made to relax emigrants and non-residents' currency exchange and remittance of domestic heritage.

Third, the capital market is further opened to the outside world. Foreign institutions have expanded their business in the domestic securities market. Foreign-funded enterprises are allowed to finance through IPO in the domestic capital market. Implementation plans are under demonstration for some global financial institutions to issue RMB bonds in China.

Fourth, RMB current account convertibility was realized in 1996. And operational procedures have been recently streamlined, offering more quotas.

Fifth, market accession and business restrictions for financial institutions are being relaxed.

Sixth, infrastructure construction of the financial market lays a foundation for the reform on the FX system. 1. China Foreign Exchange Trade System (CFETS) is to launch trading between USD and other major currencies in the interbank FX market, and to provide FX trading and clearing facilities for financial institutions. 2. The forward FX sale and purchase business will be expanded. Some commercial banks have introduced forward FX sale and purchase, including Bank of China, China Construction Bank, Industrial & Commercial Bank of China, and Agriculture Bank of China. Now the government is considering the approval of other competent commercial banks for the forward business, so as to help enterprises ward off exchange rate risks. 3. In line with the principle of national treatment, China is to open FX, money and bond markets to foreign-funded brokerages gradually. A joint venture money brokerage will be set up in the offing, and relevant regulatory rules will also be published in the near future. 4. The interbank FX market is to introduce market-making system, which is now under technical preparation and systematic testing. 5. CFETS and CME have conducted substantial cooperation to introduce FX derivatives into China. Collaborations would be carried out in the aspects of product design, system development, marketing, organizational innovation, and training. The two parties signed a Letter of Intent for cooperation in December 2003, and sealed the MOU in June 2004.

In 1994, China began to implement the managed floating exchange rate regime. At the end of 1997, China narrowed the moving range of RMB exchange rate due to the impact from the Asian financial crisis and the surrounding economies. We are satisfied with the managed floating regime from 1994 to 1997. The regime had supported China's external economic development and eliminated distortion. The stable development of China's external economy is also beneficial to the economic development in the surrounding countries and the world as a whole. The narrowed moving range of RMB is by no means permanent, for it was introduced under the specific condition during Asian financial crisis.

China will further promote its reform. This systematic engineering necessitates the comprehensive consideration of China's macro economic operation, social development, international payments, and the process of reform in China's banking system and other aspects, as well as economic and financial factors in surrounding countries and the world. Various measures have to be taken to steadily promote the reform.