Zhou Xiaochuan: Rules for developing a financial center and the reform of the
RMB exchange rate regime
Speech by Mr Zhou Xiaochuan Governor of the People's Bank of China, at the inauguration ceremony
of The People's Bank of China Shanghai Head Office, Shanghai, 10 August 2005.
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Honorable General Secretary Chen,
Honorable Mayor Han,
Colleagues and friends from the financial industry
Dear guests, and
Ladies and gentlemen,
First of all, I would like to take this opportunity to express my gratitude to all the concern and support
you have kindly rendered to the People's Bank of China over so many years, and I would also like to
thank you for availing yourself from your busy schedule to attend the inauguration ceremony of the
People's Bank of China Shanghai Head Office. On today's significant occasion, I wish to focus my
remarks on two specific issues. The first issue explores the rules for developing a financial center, and
the second issue aims to clarify questions concerning the reform of the RMB exchange rate regime.
For the first issue, the answer is quite straightforward. The People's Bank of China Shanghai Head
Office is established for the purpose of strengthening functions of the central bank head office related
to improving financial market operations and financial services.
First, both international experiences and the Chinese practices in the process of reform and opening
up have well demonstrated that greater marketization of the economy could lead to increased
crossregion economic activities, and consequently an improved integration and scale of the economy which
calls for strengthening of the functions of the central bank head office in terms of market operation and
provision of financial services. Marketization and internationalization expose economic development
undergo constant changes, leading to increased reliance of monetary policy conduct and transmission
on the money market and foreign exchange market. The development of the financial market itself will
also help to expand financial services to clients in different regions of the country and to cultivate a
limited number of financial markets serving the whole nation and even the world, not segmented
financial markets dotted across the country serving different regions. For the time being, Shanghai has
already become the harbor for some financial markets with national influence, such as the foreign
exchange market, the gold market, securities market, futures market and the inter-bank bond market
etc.
However in the past when the centralized economic system was prevalent or in the early periods of
reform when marketization was barely developed, financial organizations favored an institutional
structure featuring "parallel set-up of business departments at the subordinate and head office level"
which means branch offices of a financial institution in different locations must establish corresponding
business departments as contact points to interface with relevant departments at the head office. By
doing so, information could be collected and centralized to the highest authority that could in turn
decompose the centrally made plans level by level to different regions and localities for
implementation. With the socialist market economy preliminarily established and improved in China,
the outdated organizational structure of the People's Bank of China no longer fits in with its mandate
to improve market operation and financial services. Likewise, large financial institutions in China also
face such an organizational problem.
Second, the development of technologies and transportation facilities is producing a profound impact
on the economy and the financial industry. In the past, the underdeveloped telecommunication and
computer technology as well as backward transportation tended to restrict the economic activities and
trade to localities with little cross-region business interactions. While now, the development of scientific
technology and transportation has facilitated cross-region and even cross-country commercial
activities, increased the economic scales of financial markets and financial services and fostered the
modernization of financial infrastructures. This development has brought about dramatic changes to
financial business mode and created great challenges to the regionalized structure of institutions and
organizations. Under such circumstances, financial organizations more and more prone to set their
views on the whole country rather on different regions and financial information and professionals also
increasingly flow to financial centers providing services to the whole country. This in turn could help to
facilitate the development of infrastructures of the financial centers and the cultivations of high-end
technologies and financial products.
Finally, in today's world, a country's competitiveness depends on whether it has a dynamic financial
center. A financial center has cluster effect, i.e., it attracts and fosters financial institutions, skilled labor
force and various services, including intermediate institutions, such as legal, accounting, rating and
appraisal services. Naturally, some activities can and will be out-sourced, but the rest is fostered
based on the clustering of financial institutions and skilled labor force. In this regard, the existence of a
financial center is the yardstick of whether a country is internationally competitive and whether the
efficiency of domestic financial services can be elevated by large scales. General Secretary Hu Jintao
called for continued efforts to make Shanghai four centers of the nation, and most importantly a
financial center. In this sense, to build a national financial center is not based on the interest of a city
or a particular region. Given its responsibility in conducting monetary policy, exercising
macroeconomic management, fostering financial market development and maintaining financial
stability, the People's Bank of China must give considerations to the development of a national
financial center and carry out central bank functions based on the platform of the financial center. In
this regard, the setup of PBC Shanghai Head Office is of historical significance.
Regarding the reform of the RMB exchange rate regime, I would like to elaborate a little bit about the
contents of the basket of currencies.
As you all know, with authorization of the State Council, on July 21, 2005 China moved into a
managed floating exchange rate regime based on market supply and demand with reference to a
basket of currencies. The RMB will no longer be pegged to the US dollar. Instead, the RMB exchange
rate will be determined based on a basket of certain major currencies with assigned weights selected
in line with the real situation of China's external sector 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 of currencies, so as to maintain the RMB
exchange rate basically stable at an adaptive and equilibrium level. In this sense, it is quite natural that
people are increasingly concerned about how the composition of the basket currencies is determined.
To enhance public understanding of China's exchange rate policy, I would like to make the following
clarifications regarding the determination of the basket currencies.
As a reference for the floating of the RMB exchange rate, the selection of the basket currencies and
the determination of the weights assigned to these currencies must abide by a fundamental principle
which is to give due considerations to the countries standing as China's trading counterparts in current
account transactions and their national currencies. As you all know, there are four items under current
account, namely, trade in goods, trade in services, income (including interest income and dividend
income) and current transfers (such as remittance of overseas Chinese). To put it more simply, the
basket should be composed of currencies of the countries to which China has a prominent exposure in
terms of foreign trade, external debt (interest repayment) and foreign direct investment (dividend). And
the weights respectively assigned to these currencies should also consist with the proportional
importance of these countries in China's external sector.
- Shares of trade in goods and services should be the fundamental considerations in the
selection of the basket currencies and the weights assigned to the currencies in the basket.
Current account is a major component of China's balance of payments, whereas trade in goods and
services is the predominant item of current account. The current situation in China shows that trade in
goods and services dominates current account balance. Therefore, the shares of trade are the major
considerations in the determination of the currency components of the basket. China's major trading
partners are the United States, the Euro land, Japan, Korea, etc., and naturally, US dollar, euro,
Japanese yen and Korean won become major currencies of the basket. In addition, China also trades
significantly with Singapore, UK, Malaysia, Russia, Australia, Thailand, and Canada, currencies of
these countries are also important in determining China's RMB exchange rate. Generally speaking,
annual bilateral trade volume in excess of US$10 billion is not negligible in weight assignment,
whereas that exceeding US$5 billion should also be considered as a significant factor in currency
weight deliberation. When you look at currencies used in trade settlement, although some countries
and regions prefer US dollar as the currency for trade settlement with China, this situation is changing
gradually and trade settlement in local currencies are increasingly the choice of trading partners.
Moreover, we encourage this development. Since the basket represents currencies of countries
covering a significant share of China's external trade, the RMB exchange rate against a basket of
currencies is therefore a better indicator of the value of RMB and the changes in China's terms of
trade than that against the US dollar, and consequently serves as an important reference in achieving
basic trade balance in goods and services.
- currency structure of foreign debt should be considered
As China further opens to the outside world, the size of foreign debt incurred continue to grow
significantly. By the end of last year, China's foreign debt reached US$228.6 billion with the origins
increasingly diversified. In most cases, foreign debt repayment would require purchasing a specific
foreign currency with RMB. The resulting conspicuous demand for this specific foreign currency in the
market would become a factor influencing the RMB exchange rate. As such, in determining the
currency weights in the basket, we also take into consideration of the currency structure of China's
foreign debt.
- FDI should be considered
In recent years, rapid growth has been witnessed in FDI which has been gaining importance in our
foreign economic relations. By now, the accumulated FDI flowed into China has reached over US$560
billion, a significant part of which was denominated in the currencies of the originating economies. The
investment returns in the form of dividends will need to be exchanged into relevant foreign currency
before being repatriated. Therefore the factor of FDI has to be considered in the selection of the
basket currencies.
- current transfer items under the current account should also be considered
Though current transfers are not as important proportionally as other items in the current account, the
currency structure of these transfers still needs to be considered in the determination of the weights
assigned to the currencies in the basket.
In sum, the reform of RMB exchange rate regime to allow RMB exchange rate float with reference to a
basket of currencies is in line with the needs of diversifying foreign economic and trade relations as
well as the development of the international economic and financial system. Referring to a basket of
currencies is not equal to pegging to such a basket. Pegging means mechanically adjusting the
exchange rate of RMB against the US dollar according to the exchange rate movements of the
currencies in the basket in an attempt to keep the nominal effective exchange rate unchanged. Quite
differently, what we are having now is a managed floating exchange rate regime based on market
demand and supply with reference to a basket of currencies. In comparison with an exchange rate
regime of pegging to the US dollar solely, it can better reflect the competitiveness of RMB against
major currencies, better absorb the impact generated by an unstable US dollar and moderate the
fluctuations of RMB exchange rates at the multilateral level, safeguard the overall stability of China's
foreign economic and trade environment and consequently promote the basic equilibrium of balance
of payments as well as the sustained, coordinated and healthy growth of the Chinese economy.
Thank you very much.