China must stoutly resist pressure from developed nations to let its currency appreciate too rapidly

The People's Bank of China's unexpected announcement Saturday on the yuan's exchange rate does not mean major reforms are coming soon to the country's currency exchange rate regime.

In a lengthy statement ahead of the G-20 summit, due to be convened in Toronto, Canada, at the end of this month, the country's central bank said it will further push for the reform of the renminbi exchange rate formation mechanism and increase its flexibility at a time when the global economy is well on the way to recovery and the Chinese economy is on a sound footing.

China's decision to revamp the renminbi exchange rate regime should focus on reforming the rate formation mechanism and should proceed in line with supply-demand principles.

The country should implement a "dynamic management and adjustment" system for the yuan's exchange rate given the fact that there is no basis for drastic fluctuations or changes to its value.

Saturday's news has sparked strong reactions and speculation both at home and abroad, with some analysts believing the move symbolizes Beijing will resume the disrupted process of exchange rate reform launched in mid-2005.

Some also believe the adoption of a flexible rate signals the start of the yuan's appreciation and the country's substantial steps towards adjusting its exchange rate policy under pressure from the United States.

However, the latest statement by China's monetary authority is only a reaffirmation of the country's basic principles on the currency's exchange rate since reforms were launched on July 21, 2005 and its willingness to shift from the yuan's peg to the US dollar, a move the country adopted in mid-2008 in the wake of the global financial tsunami.

No in-depth studies have so far been conducted on the impact that the reform of the renminbi exchange rate has caused on the Chinese economy over the past years, but one thing is sure - the drastic decline of China's exports from the second half of 2007 through 2008 and the bankruptcy of a number of domestic enterprises, export-reliant ones in particular, were largely caused by a fast rise in yuan's value.

Therefore, the country should ponder over the reasons underlying its economic downturn that emerged in the second half of 2008 and should not rush to embrace those policies it adopted since July 2005 regarding the yuan's exchange rate.

The central bank's latest stance does not necessarily foreshadow yuan's revaluation. A flexible exchange rate of the yuan leaves the possibility of both appreciation and depreciation, in which market elements will exercise the largest say in deciding which tendency should dominate.

The reform of the yuan's exchange rate formation mechanism is a key effort by China to reform the renminbi rate regime.

However, as a currency whose exchange rate has just broken away from a planned economic era and begun to succumb to a market-based system, the establishment of such a mechanism should be based on some well-designed institutional arrangements. It should also be a gradual and long-term process.

As an emerging economy with fledgling market rules, it is impossible and also impractical for China to put in place an exchange rate formation mechanism like how developed countries do.

Developed countries also remain impotent to iron out many shortcomings and defects existing in their monetary policies, which leave much room for artificial manipulations on this score.

Having turned a blind eye to their own exchange rate problems, it is unreasonable for developed countries to pressure China to reform the yuan's exchange rate regime completely in line with the market rate mechanism.

The central bank's stance that there is no basis for drastic fluctuation and changes to the yuan's exchange rate is praiseworthy. However, such a statement alone is by no means enough.

The renminbi exchange rate issue should be resolved not only according to market principles, but also in line with China's national interests. The reason why the US has long pressured China to appreciate the value of its currency, sometimes in a coercive tone, is to safeguard its own interests.

As a leading world currency, the dollar should undertake its just responsibilities in maintaining the stability of the international financial market. The dollar's dominant status has also brought the US huge gains. China's policy of pegging the yuan to the dollar is completely a kind of market behavior under the current financial situation at home and abroad.

China's promise to further push for the reform of the yuan's exchange rate formation mechanism and increase its flexibility serves as an important tool to make the exchange rate more market oriented.

But that does not mean the yuan would be revalued or that the currency will appreciate as rapidly as it did during 2005 to 2007. Under the current economic environment, what China should pursue is not only global economic recovery, but also a stable exchange rate in order to maintain sustainable development of its national economy.

A stable exchange rate will not only serve the Chinese economy but also that of the whole world. The Chinese government should try to resist any pressure from overseas on the yuan's exchange rate and prevent any fast revaluation of its currency.

The author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences

(China Daily 06/22/2010 page8)