China Leans Toward Yuan Float

Professors and politicians alike agree that the mechanism of RMB exchange rate is suitable for a new round of reforms.

Monetary policy of the Chinese government is at a new juncture. Several quasi-governmental and independent research organizations conducted earlier this year closed the discussion of exchange mechanisms, and submitted proposals to the central bank and politicians.
What's next? Everything indicates that China intends to resume the reform of the exchange rate, which were halted in July 2008 with the start of the international financial crisis.
During a press conference on March 6, deputy chairman of the People's Bank of China Su Ning (Su Ning) said that the central bank would decide when to begin the process of eliminating "special mechanisms of exchange and provide a specific timeframe based on the economic situation.
"Exit" has been interpreted by markets as a sign that the central bank allows the yuan meet their real value. The rumor that the yuan would allow a one-time adjustment rate of 2% -3% coverage of the entire market. "Some Chinese financial institutions have already begun to get rid of U.S. dollars", - said the executive director of a major financial institution in Hong Kong.
Discussion rate adjustments led to different reactions in the market. China's export sector was the strongest opponent of the proposed changes, stating that the sudden appreciation of the yuan would be equivalent slammed on the brakes of the global economic recovery.
Some economists say that, relying only on the economic perspective, it is impossible to measure whether the yuan to move upward or downward. They recommend a policy of a fixed rate, instead of blindly at the moment of action when faced with uncertainty. If reform of the exchange rate will cause rising expectations of further increases in the value of the yuan, the flow of hot money in China will increase sharply, creating a glut of liquidity and may bubble out of the assets that will reproduce the situation after the reform of the exchange rate in 2005.
Nevertheless, some argue that the reforms of the exchange rate is better happen sooner rather than later. Despite international pressure, and even though that further reform of the exchange rate again point to the adjustment of the yuan, in this situation, there are distinct advantages.
Exports have increased sharply since China became a leader of the world economic recovery. Effective exchange mechanisms will not only reasonable fixed prices for exports and imports, increasing China's trade position, but it could also potentially contribute to the normalization factor is not sold and traded goods. This could balance the important factors of production, as domestic labor, land and natural resources. It will also increase the level of consumption and benefit the national economy.
Caixin chief economist Yiping Huang (Huang Yiping), a professor at Beijing University National School of Development, is a supporter of market mechanisms. "Yuan needed market-oriented mechanisms, rather than a one-time adjustment," - said Huang.
The current position of the Chinese government on exchange rate policy aimed at maintaining the yuan's exchange rate within a framework that polismeykery consider fair and balanced. With this in mind, senior managing director who is familiar with exchange controls, said that the progressive movement in the future could bring more benefits than a sudden leap.
"No matter what method is chosen, the policy of exchange rate adjustments should be proactive, managed and implemented gradually. Actions at the pre-emption - a top priority ", - said the executive director. "Adjustments in rates of exchange, of course, will be carried out gradually. Occasional sharp corrections appropriate for polismeykerov.
Various schemes
Ting Lu (Lu Ting), economist at Bank of America Merrill Lynch China, confident of a rapid adjustment. "In the medium and long term, we are definitely going to watch freely floating yuan and correction", - said Liu. "The question is: what scheme to choose."
Relatively extreme scheme will lead to rapid and one-time adjustment of the RMB against the U.S. dollar, which would have confirmed the predictions. One-time adjustment usually leads to an increase of about 20% and shall be held within three to five years.
Many experts are against this, calling such actions by radical methods. A senior official of the central bank said that any talk of a substantial one-time adjustment of the RMB will only occur at the level of academic theories and not feasible at the political level. "There were no significant adjustments to the yuan has never been" - said a bank official. "Enterprises can not rely on it."
A more likely scenario would have anticipated resumption of conservative, floating exchange mechanisms, which used the central bank from July 2005 to July 2008, and allowed the yuan to gradually adjusted against the U.S. dollar.
However, the shortcomings of the floating method are obvious. If the market expects the yuan to unilaterally would be adjusted against the U.S. dollar over a long period of capital from abroad will fall gradually in China, which will lead to a jump in foreign reserves and asset prices, as well as an overabundance of liquidity.
In addition, the combination of strong expectations and the actual adjustments, gradual adjustments would result in accelerating the pace of changes in value of the yuan. Yuan rose by 3.35% against the U.S. dollar in 2006, 6.8% in 2007 and 6.9% in the first seven months of 2008.

Some experts have advocated the internal price reforms and "moderate inflation" rather than reform the exchange rate, as a more correct way to achieve de facto revaluation of the yuan.
The method of redistribution of wealth through the prism adjustment yuan was criticized for a fundamental flaw: the increasing prices of essential everyday goods will lead to negative consequences.
The chief economist of China International Capital Corp., Ha Dzhiming (Ha Jiming), said that people can still rent an apartment, if the value of houses will be out of reach. But if food prices rise, it will be bad for everyone, including people with low income, that could pose a threat to social stability.
Basket Currency
A source close to the central bank, said that incremental adjustments to suit most of all, as there are supply flexibility for reform of the exchange rate. If circumstances permit, said the source, the government properly can extend the daily range of fluctuations of the yuan.
Other experts expressed the need for "new methodology" for determining the exchange rate mechanism, for example, in the method a basket of currencies.
Ha recommends letting the yuan to be valued based on a basket of currencies. Similar views are held by Ding Zhizhi (Zhijie), Dean of the School of Banking and Finance in the University of International Business and Economics, who called for "de-dollarization" of the yuan.
Ding recommends the establishment of exchange rates based on the proportion of trade volume of exports and imports, on the cash basis of which each country will be represented in the total trade of China. Cart must consist of 18 currencies, he said, with the share of euro 17.91%, 14.68% of the U.S. dollar and other currencies totaled 56.15% of the total. "It is extremely important to promote sustainable trade", - he said.
A source close to the central bank, said that the authorities should determine the weighted ratio for a basket of currencies, considering first the proportion which the currency is in commercial transactions. Currently, over 70% of international trade transactions made in U.S. dollars, the remaining 30% rate in the euro and pound. Most of the debt of the Chinese foreign debt ($ 400 billion dollars) are denominated in dollars and borrowing money to repay debt, has required a certain amount in dollars. Fluctuations in the market and would require appropriate adjustments.

There are different views as to whether to disclose the specific weight of each currency in the basket. Liu and Huang in favor of copying the Singaporean system of exchange rates, as the authorities did not disclose the weight of the currency, and yet the system allows for adjustments to specific rates based on market conditions.
If China takes the approach of Singapore, the daily setting of the central rate of the yuan relative to fluctuations in the currency basket will revolve around variations of the nominal effective exchange rate of the yuan. "Advantage" of this method lies in the flexibility and freedom of action during the fluctuations in foreign currency ", - said Huang.

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