Is it time to move to a floating exchange rate?

By Xu Qiyuan Source:Global Times Published: 2018/3/26 23:58:39

Illustration: Luo Xuan/GT


Over the years, the yuan exchange rate regime has generally lacked flexibility, which has constrained the People's Bank of China (PBC)'s monetary policy. In a sense, China's monetary policy framework starts with the exchange rate policy, and many people believe the monetary policy actually serves as the exchange rate policy to some extent. This view reveals the constraints that China's monetary policy is facing.

From the perspective of the economic fundamentals, the issues affecting China in choosing the exchange rate system are undergoing profound changes. These changes will allow the transition of China's exchange rate system to be successful and will help with the establishment of a mature monetary policy framework that will be independent from the exchange rate policy.

First, in recent years, there has been a significant drop in the degree of dependence on exports. In 2006, China's exports accounted for over 30 percent of GDP. Since then, this ratio has dropped continuously. Exports, as one of the engines of the Chinese economy, are losing importance.

Chinese companies have gone through numerous hardships in the global market over many years, and their competitiveness has been able to withstand the exchange rate fluctuations. Therefore, a more flexible exchange rate is more achievable.

Second, there is not so much pressure in terms of employment now. In the past, maintaining growth was necessary to ensure employment, but this is no longer a big problem.

Since 2013, there has been little increase in the number of new urban jobs; it was 13.51 million in 2017. The average growth in the last four years was only 100,000. However, under such circumstances, the overall employment situation has remained basically stable.

It can be seen that, in the context of an aging population and declining employment pressure, holding exports and foreign exchange rates steady in order to maintain employment is of less and less importance.

Third, after the reshaping of the financial regulatory framework, regulators will be better able to deal with and contain financial risks. In July 2017, the National Financial Work Conference put the prevention of systemic risks in a prominent position. At the 19th National Congress of the Communist Party of China in October 2017, it was also listed as the first of three major tasks. The government work report of March 2018 made specific arrangements for the work to be done this year, and the local government debt problem will also be a priority.

At the same time, the Financial Stability and Development Commission and the merger of the China Banking Regulatory Commission and China Insurance Regulatory Commission will pave the way for the complete clarification of financial supervision. The problem before 2016 was lack of supervision, but this is being addressed.

Starting from 2018, the coordination of various regulatory departments will gradually increase, and the effectiveness of supervision will also increase significantly. In this context, the development of financial markets will provide a more solid market foundation for the yuan exchange rate to float freely.

Finally, the external environment faced by the PBC is undergoing profound changes, and the time window for the yuan exchange rate to move toward flexibility will come again. Timing will be of the utmost importance. Allowing the yuan to float freely when there are devaluation expectations could lead to attacks from the international market, and even a currency crisis. But if the market expectation is for appreciation or a balanced trend, the risks will be much smaller.

Regarding the US, the dollar has started on a relatively weak trend, and this is exactly what the US Department of the Treasury and the US government would like to see. At the 2018 World Economic Forum in Davos, US Treasury Secretary Steven Mnuchin made it clear that weakening of the US dollar would be beneficial for the US. President Donald Trump also attaches great importance to the US trade deficit and hopes to reduce it using various methods. So Trump definitely does not want to see a significant appreciation of the US dollar, especially against the yuan.

The author is a senior fellow with the Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

Posted in: INSIDER'S EYE

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