Reform and Opening up

Yuan exchange system reflects 30-year change

By Liu Junhong (China Daily)
Updated: 2008-12-26 07:51

In the 30 years since China began reform and opening up, the renminbi and its exchange system have undergone some significant changes, mirroring the nation's changes during this period.

After 30 years of persistent exploration amid dramatic changes happening around the world, China has blazed a unique trail that can be called the "Chinese Format". China has entered a new era while joining the global system.

During the process, China has developed from a country blockaded by the West from doing trade with the rest of the world into the "world factory" and "world market".

The Shanghai Stock Exchange, which opened for trading in the early 1990s, has grown into a securities market that investors worldwide simply cannot ignore today. Remember the nerve-wracking fluctuation of the Shanghai Composite Index in February 2007? For a while financial markets around the world believed Shanghai was the epicenter that sent shockwaves through stock markets all over the world.

Meanwhile, China's favorable balance of trade has been setting new records year after year. With its forex reserve close to $2 trillion today, the country is not only the undisputed No 1 holder of hard currencies but also a key driving force ensuring the stable development of the world economy. And the renminbi has emerged from obscurity and developed into a burgeoning currency the whole world is watching with growing interest.

Beginning in 1982, the renminbi's nominal exchange rate went through a period of adjustment characterized by 14 years of downward tweaking until it was brought "on track" with the international exchange rate mechanism in 1994.

The adjustment of the renminbi exchange rate system back then was not only a historical correction of the rigid and obsolete renminbi exchange rate policy practiced until the reform and opening began. It was also a natural choice by the central government to make sure it stayed on the course of reform and opening up.

After the renminbi exchange rate was integrated with the exchange market mechanism, especially after China became in 1996 an Article VIII member country, which promises to realize free convertibility of capital accounts in phases, the nation practiced nearly 10 years of "managed floating exchange rate mechanism" until it launched the exchange system reform on July 21, 2005. It is also known as the de facto delinking of the renminbi with the US dollar.

As a matter of fact, China's economy went through a historic turning point during that period, while the renminbi weathered the real challenge from the Asian financial crisis. The country formally stepped onto the path of market economy after late leader Deng Xiaoping made his milestone speech on a historic tour of south China in 1992. The nation began earnest negotiations for admission into the General Agreement on Tariffs and Trade and its successor, the World Trade Organization, as the country's economy was faced with the most difficult time.

In the meantime, the Asian financial turmoil broke out in July 1997. The Chinese government thoroughly honored its promise to keep the renminbi exchange rate stable, maintaining not only China's resolve to advance along the path of a market-oriented economy but also the stability of the financial and monetary systems of all Asian economies. As a result the experience also laid down the historic foundation for China's rallying power and the credibility of the renminbi in the region.

China's reform and opening up has brought its economy into the global system, where the renminbi and its system are bound to have direct relations and even frictions with other currencies. After China joined the WTO in 2001, foreign investments poured in while the country's exports expanded, and currency-related disputes followed as a sequel.

In spring 2001, Japan took the lead in accusing China of undervaluing the renminbi, in total disregard of the fact that the Chinese currency was far from ready for free trading as China's reform and opening up still had a long way to go. In 2003, Japan called for discussions about the renminbi exchange rate at the G7 finance ministers' meeting. Its aim was to make the Chinese currency a "scapegoat" for its own yen, which was under mounting pressure from the US and European Union to appreciate. The trick worked and a renminbi version of "the Plaza Accord" was reached at that meeting.

On July 21, 2005, the Chinese government voluntarily began reforming the renminbi exchange rate system, while Japan kept its policy of zero interest rate and relaxed monetary base in force. Thus the renminbi embarked on the journey of appreciation against all major currencies, including the US dollar and Japanese yen.

The truth is: As a major player in processing trade, China cannot address its huge trade surplus issue simply by raising the renminbi exchange rate against other currencies. Why? Because cross-national conglomerates invest in China to process and assemble products with parts and raw materials they have sourced outside the country and sell the finished products overseas.

The result of Japan's recommendation would be the effect of higher prices of China's export products. This will be caused by renminbi appreciation being offset by reduced prices of raw materials that foreign companies import to China for export processing.

It actually diverted the pressure on the Japanese yen to appreciate and allowed Japan to continue practicing its very relaxed financial policy. And a direct result of consequent position adjustments sowed the seed of a global financial crisis.

The author is a researcher with China Institute of Contemporary International Relations