Hu Xiaolian: Successful experiences of further reforming the RMB
exchange rate regime
Article by Ms Hu Xiaolian, Deputy Governor of the People's Bank of China, Beijing,
30 July 2010.
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China moved into a managed floating exchange rate regime based on market demand and
supply with reference to a basket of currencies on July 21st, 2005. Positive results produced
thereafter showed that the reform was launched at the right time in the right direction.
I. The reform of exchange rate regime has been furthered at an appropriate time
It is at the 3rd Plenary Session of 14th CPC Central Committee that the goal of establishing a
managed floating exchange rate regime based on market supply and demand was outlined.
In January 1994, with the unification of RMB's official exchange rate and swap rate, the
single, managed floating exchange rate based on market supply and demand was officially
adopted. The RMB exchange rate gradually approached an adaptive level, which helped
enhance the competitiveness of export-oriented enterprises and facilitated the shift from
trade deficit to surplus.
During the Asian financial crisis in 1997, the RMB exchange rate was kept stable around
8.3 yuan to one dollar in order to brake competitive devaluation of Asian currencies. Though
the impacts of Asian financial crisis subsided in 2001, the RMB was kept at a stable level
against the US dollar as unfavorable factors, such as deflation, arose domestically.
Reflecting on the crisis, China stepped up the financial reform and infrastructure building.
Researches and preparation on resuming exchange rate floating were also well underway.
As financial institutions had not completed reform and were not yet prepared to handle
exchange rate movements or provide enterprises with relevant services, the reform of
largesized state-owned commercial banks was conducted before exchange rate reform.
The reform in large financial institutions, which is the basis for exchange rate regime reform,
was completed by July 2005. The Bank of Communications, China Construction Bank and
the Bank of China finished financial restructuring and became listed companies. The financial
restructuring of Industrial and Commercial Bank of China was put on agenda and the
preparation for the reform of China Development Bank and the Agricultural Bank of China
was underway. In addition, China's accession into the WTO had significantly enhanced the
competitiveness of export-oriented enterprises. With continued expansion of trade surplus,
Chinese enterprises and financial institutions were better prepared for the reform of the RMB
exchange rate regime. With these conditions in place, the reform of exchange rate regime
was launched decisively.
Around end July 2008, in order to address the deepening international financial crisis, China
narrowed the floating range of RMB exchange rate and did not devalue the currency as
many other countries did. This contributed much to stabilizing external demand, helped
mitigate the impacts of the international financial crisis, and promote Asian and global
economic recovery. Global economy is now recovering and China's economic recovery and
upturn is more entrenched. In this context, as approved by the State Council, the PBC
decided to further the reform of exchange rate regime and enhance the flexibility of RMB
exchange rate on June 19, 2010. New challenges may arise as international economic and
financial situations evolve, but the reform of RMB exchange rate regime will continue in line
with our established policy.
II. The exchange rate regime is consistent with the market-based economic
reform in China and an integral part of the restructuring package
China has moved into a managed floating exchange rate regime based on market demand
and supply with reference to a basket of currencies. This is a right choice based on China's
specific circumstances and development strategy. As an important component of the socialist
market system and in line with the scientific approach to development, the exchange rate
regime is needed in the country's endeavor to deepen reform and opening-up, and adapt to
the new situation after China's accession into the WTO. In line with China's long-term and
fundamental interests, a managed floating exchange rate regime is an inevitable choice that
will facilitate economic restructuring and comprehensive, balanced and sustainable
development, help strengthen macroeconomic management and facilitate China's economic
development at the juncture of strategic importance.
The goal of China's economic policies is economic growth, full employment, price stability
and a balanced BOP account. A package of restructuring measures is needed to address
structural problems of high savings rate and inadequate domestic demand. In this package,
exchange rate policy plays a role no less important than general industrial policies as it has
an impact on domestic and foreign relative price in an aggregate sense. A misaligned
domestic and foreign relative price leads to the distortion of domestic prices and undermines
the stable, balanced and sustainable development of the economy. A proper mix of other
structural policies and exchange rate policy can be more efficient in facilitating a
wellfunctioning pricing mechanism. What has been achieved showed that, since the launch of
the reform in 2005, the restructuring package has created a basis for exchange rate policy to
play a fundamental role in domestic and external sector resource allocation, and the
successful launch of the exchange rate regime has created a more facilitating environment
for other reforms, such as the reform of resource prices. Moreover, exchange rate policy,
together with lifting import control, easing foreign exchange control and accelerating the
"going global" initiative, has played an important part in halting further accumulation of BOP
imbalance. Improved flexibility of exchange rate also helps make macroeconomic
management more proactive and efficient.
III. The positive results since the exchange rate regime reform in 2005
Core competitiveness of the corporate sector has been strengthened as a result of
heightened efforts to upgrade and innovate products. This facilitated the optimization of
export structure and the shift of trade and growth pattern. From 2006 to 2008, the structure of
China's exports further improved. The share of machinery, electronic products and high-tech
products continued to rise while the export by high-pollution, high-energy consumption and
resource-intensive industries had been restricted. The share of export to developing
countries and emerging markets went up while that to the developed countries declined.
Meanwhile, the process of "Attracting Foreign Investment, Technology and Management
Expertise" and "Going Global" gained momentum, enabling China to play a bigger part in
global industrial chain and the international market. Being more responsive to exchange rate
movements, large amount of export-oriented enterprises conducted proactive financial
management and raised selling prices to cover exchange rate losses. Improved in quality,
China's foreign trade registered further development.
Domestic demand supported by import expansion and lower import cost helped ease
inflationary pressures. From June 2005 to June 2008, China's import volume totaled
US$2.729 trillion. A total of 1.6497 trillion yuan of import cost was saved as a result of RMB
appreciation against the dollar. Massive technology and equipment imports facilitated rapid
improvement of China's capacity and productivity. Moreover, yuan appreciation against the
US dollar in this period lowered the RMB-denominated price of import products and
cushioned the impacts brought by the rise of international raw material price on domestic
price level, which directly eased domestic inflationary pressures.
Resource allocation was optimized, promoting economic restructuring and more balanced
development. As a result of macroeconomic policies including exchange rate policy, the
industrial structure became more balanced with the service industry contributing 42.9 percent
to GDP growth in 2008, a growth of 2.6 percentage points from 2005. The geographical
distribution of industries improved as the labor-intensive industry accelerated its reallocation
to the central and western part of China, facilitating the implementation of national
development strategy. In 2008, share of central and western region in China's GDP was
37.1 percent, up 1.3 percentage points from 2005. As more resources have been channeled
to economic sectors driven by domestic demand, domestic demand contributed 90.8 percent
to economic growth in 2008, up 14.9 percentage points from 2005. The concentration of
labor force in the export sector as a result of an undervalued exchange rate has been partly
corrected as more jobs have been diverted to the services industry, which is largely
nontradable. According to the National Bureau of Statistics (NBS), the number of people
employed in the services industry as a percentage of total employment increased by
1.8 percentage points between 2005 and 2008. In the long run, the manufacturing industry
will evolve from a labor-intensive industry to a capital-intensive one, providing fewer jobs.
The services industry, in comparison, is by nature a labor-intensive industry and can create
more jobs in a sustainable manner.
The reform of exchange rate regime has demonstrated to the international community
China's commitment to promote global economic balance, providing a more facilitating
international environment. A floating RMB exchange rate shows that China is dedicated to
promote global economic balance and that China is a responsible member in the
international community. This helped ease the tension in China's trade relations with foreign
countries and lessen trade protectionism attempts targeting China. Between 2005 and 2008,
trade remedy investigations against China were mostly cases limited in size and scope and
did not harm the free and open trade environment in China. In this context, China maintained
high growth and low inflation for a fairly long time.
IV. A dynamic approach is needed to assess the impact of exchange rate reform
on the corporate sector
The potential adverse impact of the RMB exchange rate reform in 2005 was effectively
managed thanks to the principle of making the reform a self-initiated, controllable and
gradual process. The corporate sector became increasingly resilient to the reform, which was
reflected in improving import and export indicators amid a host of shocks, including a
stronger RMB, lower export rebate rate and rising labor cost. Export was not substantially
affected. From 2006 to 2008, the golden period for China's foreign trade, export grew by
23.4 percent annually, and import by 19.7 percent. Exchange rate floating helped upgrade
the export model from simple processing to deep and intensive processing, extended the
production chain, and improved division of labor, ultimately contributing to higher
employment. According to the NBS, total employment increased by 16.55 million during the
period from 2006 to 2008.
Before the exchange rate reform was launched, there were concerns that companies could
not adapt to the reform, and a floating exchange rate would thus lead to widespread
shutdown and sharp decline in export and employment. There were also people who
believed a 3 percent appreciation would result in mass closures and bankruptcy in textile and
light industries. Looking back, these concerns reflected an overestimation of the side effects
of the reform and an underestimation of companies' resilience. They are a result of the then
popular static approach to studying policy implications, which assumes a constant cost,
pricing and profitability and then observes the direct impact of exchange rate reform on
selected economic indicators. In fact, most Chinese companies have developed the ability
and mechanism to adjust to changes in the market after nearly three decades of
marketoriented reform, which warrants the application of dynamic analysis.
Static approaches, including assessing exchange costs of exports and sales profits, did not
fully capture the flexibility and adaptability of the corporate sector. In addition to expanding
profits through technological upgrading and product innovation, exporters could transfer the
cost of a stronger domestic currency by raising price. Moreover, exporters with import
businesses would benefit from lower import costs, and exporters who also sell to the
domestic market could offset exchange cost by selling more to domestic consumers. In
addition, companies can employ a wide range of flexible finance management means to deal
with exchange rate movements.
In an ever-changing market environment, the corporate sector manages market and other
risks including exchange rate risks in a dynamic manner. Operating in a market economy, an
enterprise has to face many changing parameters, including raw material prices, wage,
export tax rebate, market demand, distribution channel, product mix and cycle, public utility
price, and etc. The annual movement of any of these factors is often more than then
10 percent. As one of these variables, the exchange rate usually does not experience large
swings. In a market economy, it is no longer feasible to adopt the planned economy
measures to fix the external factors for enterprises. In a globalized environment, enterprises
have fewer and fewer risk free long-terms orders and have to accept orders with shorter
maturities. Enterprises around the world are adapting to the changing market conditions,
including the changes in demand, distribution channel and price of input and output,
exchange rate, hedge price, insurance price, and etc, and are managing the risks through
information technology (such as low or zero inventory, shorter production cycle and
outsourcing) and financial instruments.
It is important to look at the situation in most industries and companies to assess the impact
of exchange rate movements. While some of the industries and companies manage to grow
through innovation, others lag behind and are eliminated. Vulnerable companies are the first
to feel the pressure to adjust, and they should be supported by policies to improve the social
safety net and enhance training programs to improve labor force quality and adaptability. The
competitiveness of the manufacturing sector as a whole, rather than that of individual
companies, should be the focus in measuring the impact of exchange rate movements.
Similarly, the assessment of the exchange rate regime reform should mainly look at the
overall trade situation and the improvement of development quality.
Information and voice that are prone to systemic deviation need to be assessed properly.
Exchange rate movements bring gains and losses to different companies. To win policy
support, companies tend to highlight the losses in export, profits and employment while play
down merits of the reform, such as reduced import costs. This helps generate a negative
picture of companies' ability to deal with exchange rate movements. Therefore, a careful and
comprehensive analysis is needed in order to produce a subjective assessment.
In summary, the RMB exchange rate regime reform has been advanced smoothly in a
selfinitiated, gradual and controllable process since 2005. The reform plays a positive role in
supporting the real economy, and creates favorable conditions for meeting macroeconomic
management objectives. It helps promote a balanced BOP account, expand domestic
demand and restructure the economy, and has been important in China's efforts to address
various domestic and global developments.