To Accomplish the Unaccomplished Reform： Lessons and Options of RMB Exchange Rate Reform

The exchange rate reform initiated on August 11,2015 is an important attempt by the PBoC to transform China's exchange rate regime from the "crawl-like arrangement" to a floating regime.However,after a three-day experiment,the PBoC abandoned the original goal of the reform.Since then,the central bank has implemented a new exchange rate-setting mechanism.Under this mechanism,the central parity of the renminbi(RMB) against the US dollar is decided by the arithmetic average of the RMB exchange rate that keeps the index of a currency basket unchanged over the past 24 hours and the previous day's closing price of USD/CNY.Due to the introduction of the index of a currency basket,additional uncertainty has been introduced into the determination of the RMB exchange rate,because of the uncertainty of the dollar index(USDX).As a result,to a certain extent,the one-way bet on the RMB expectations is weakened.However,the current exchange rate formation mechanism cannot reverse the trend of devaluation of the RMB,nor can it eliminate depreciation expectations.Meanwhile,it hinders the effectiveness of central bank's independent monetary policy based on the domestic economic fundamentals.And also,the "two-way float" created by the new price-setting mechanism is artificial and has led to significant losses of foreign exchange reserve.The paper explains how the new price-setting mechanism works,and identifies the important features of the mechanism and its pros and cons.The paper argues that despite some advantages,the new exchange rate regime as a soft peg regime is not sustainable and the PBoC should stop foreign exchange market intervention as soon as possible.We hope that the PBoC can learn the lessons from the failure of the "August 11 reform" and accomplish the unaccomplished reform in an urgent manner.

Structural Evolution of RMB Exchange Rate Reform: Historical Review, Experience and Prospect

The Renminbi(RMB)exchange rate regime reform has gone through three stages roughly once every decade since 1994.It is a structural evolution through the unification of dual exchange rates,increased fluctuations and central parity rate reform in response to the dynamic macro environment in China and abroad.This paper unpacks leading and supporting reforms for each stage and reviews the effects.The reform has developed historical experience in adopting progressive strategies,avoiding sharp exchange rate fluctuations in the near term,maintaining appropriate capital controls,and guaranteeing the reform through domestic structural reforms.Achieving a free-floating exchange rate will be the ultimate goal,but it will not be made easily in the short run.During the transitional period,it is recommended that an annual target zone for RMB's effective exchange rate be arranged for the CFETS currency basket,along with necessary capital controls.

Putting the Cart before the Horse? Capital Account Liberalization and Exchange Rate Flexibility in China

This paper reviews the issues involved in moving towards greater exchange rate flexibilityand capital account liberalization in China. A more flexible exchange rate regime wouldallow China to operate a more independent monetary policy, providing a useful bufferagainst domestic and external shocks. At the same time, weaknesses in China’s financialsystem suggest that capital account liberalization poses significant risks and should be alower priority in the short term. This paper concludes that greater exchange rate flexibilityis in China’s own interest and that, along with a more stable and robust financial system, itshould be regarded as a prerequisite for undertaking a substantial liberalization of thecapital account.

Dynamic Transition of Exchange Rate Regime in China

Thepaper considers the optimal transition path for China＇s exchange rate regime. How can China successfully make the shift from the current dollar peg regime to a more desirable regime, whether a basket peg or a floating regime？ To answer this question, we develop a dynamic small open economy general equilibrium model. We construct four transition policies based on a basket peg or a floating regime and compare the welfare gains of these policies relative to maintaining the dollar peg regime. Two main results are derived from the quantitative analysis using Chinese data from 1999Q1 to 2010Q4. First, following a gradual adjustment to a basket peg regime is the most appropriate path for China to take, with minimal welfare losses associated with the shift in the exchange rate regime. Second, a sudden shift to the basket peg is the second best solution, and is superior to a sudden shift to floating because the monetary authority can efficiently determine optimal weights to attach to currencies in the basket to achieve policy goals once they adopt a basket peg regime.

RMB Exchange Rate Regime: Suggestions on Further Reform and Exit Strategy

Since 2000, the focus of the study of the RMB ex change rate has transferred from debate on whether it should appreciate or depreciate to the overall planning and the envisaged improvement of the RMB exchange rate regime.

Currency Exposure in China under the New Exchange Rate Regime： National Level Evidence

The present paper studies China＇s national level currency exposure since 2005 when the country adopted a new exchange rate regime allowing the renminbi （RMB） to move towards greater flexibility. Using generalized autoregressive conditional heteroskedastic and constant conditional correlation-generalized autoregressive conditional heteroskedastic methods to estimate the augmented capital asset pricing models with orthogonalized stock returns, we find that China equity indexes are significantly exposed to exchange rate movements. In a static setting, there is strong sensitivity of stock returns to movements of China＇s trade- weighted exchange rate, and to the bilateral exchange rates except the RMB/dollar rate. However, in a dynamic framework, exposure to all the bilateral currency pairs under examination is significant. The results indicate that under the new exchange rate regime, China＇s gradualist approach to moving towards greater exchange rate flexibility has managed to keep exposure to a moderate level. However, we find evidence that in a dynamic setting, the exposure of the RMB to the dollar and other major currencies is significant. For China, the challenge of managing currency risk exposure is looming greater.

Trilemma,RMB exchange rate regime reform,and policy orientation after August 2015

The discussions on RMB exchange rate could not depart from the ongoing reform of RMB exchange rate regime,which must be designed and promoted as an integral part of the large open economy macroeconomic policy framework.As a large open economy facing the trilemma,China should explicitly establish the principle of domestic monetary policy dominance in the impossible trinity,with the exchange rate policy and capital account management should both conform to this fundamental principle.Simplistically pegging RMB to the US dollar will result in lack of flexibility and violate this principle.Especially against the backdrop of unsynchronized economic cycles of major economies and the prospect of further Fed tighten up,that the real effective exchange rate of RMB moves passively along with the US dollar cannot reflect the relative changes in economic fundamentals in China and abroad,which will cause distortions,resulting in resource misallocations and loss of welfare.The reform of RMB exchange rate regime should be market-oriented,towards a direction with more flexibility.

US monetary policy uncertainty and RMB deviations from covered interest parity

This paper examines how US monetary policy uncertainty(MPU)affects RMB deviations from covered interest parity(CIP)and how this effect is influenced by China’s capital controls,the RMB exchange rate regime,and international reserves that constrain the transmitting channel of US MPU shocks.Our findings show that US MPU has a spill-over effect and creates deviations from RMB CIP.Capital controls insulate uncertainty shocks and alleviate the US MPU spill-over effect.There are some evidence that inter-national reserves alleviate and the liberalised RMB exchange rate regime magnifies the spill-over effect.However,their effects become insignificant in the presence of capital controls.Moreover,the US MPU effect on RMB CIP deviations becomes prominent after the 2008 global financial crisis.

International Financial Adjustment for China:A Financial Valuation Approach

International financial adjustment is the process whereby valuation shifts from asset price and currency changes result in relatively durable net wealth transfers across countries＇ international balance sheets. Thispaper applies a financial valuation approach to estimate the direction and the broad extent of recent international financial adjustments on China international balance sheet. We estimate China＇s international balance sheet losses resulting from the valuation shifts over the period 2005 2010 and reveal that international currency shifts over the past decade have also generated a range of non-balance sheet financial and monetary adjustment pressures for China. This paper also evaluates how China＇s evolving international financial policy arrangements could better mitigate China＇s exposure to international financial adjustments. These arrangements include a more effective currency mechanism and the mechanisms to internationalize the RMB to buffer international financial valuation shocks

Robust Monetary Framework for China

China faces rising current account surpluses and foreign reserves. Maintaining the fixed exchange rate runs the risk of overheating of the economy. It is desirable to pursue greater flexibility of the exchange rate regime in the short run, and gradual liberalization of capital account transactions in the medium run. Proper sequencing of various steps is recommended to prevent financial crises. Japan＇s transition from the dollar peg to a more flexible exchange rate system in 1971-1973 is considered to be a mistake, whereas the gradual capital account opening from the mid-1970s to mid-1990s is considered a success. The present study also analyzes Korea＇s mistake in opening its capital markets too far ahead of exchange rate flexibility, and liberalizing short-term capital rather than long-term capital. The challenge before China is similar to Japan＇s of 1969-1970, in the sense that the transition from the dollar peg is inevitable and desirable for the country, but decisive actions with proper sequencing are important.