The Choice Of RMB Exchange Rate Regimes

Today, China's economy has fully integrated into the world economy. The RMB exchange rate issue has become a focal point in the field of international finance. In the view of our development process, our foreign exchange regime was highly centralized and unified before China's reform and opening up. And during this period, our foreign exchange regime was entirely determined by the Government and the market mechanism has completely ignored. Between 1979 and 1993, the market-oriented factors gradually appeared in China's foreign exchange regime. At the same time, the"Dual Exchange Rate Regime"was determined which included the internal trade price and the announced exchange rate. In 1994, the merger of RMB exchange rate regimes achieved and the single managed floating exchange rate regime which was based on market supply and demand was determined too. Actually, Chinese Yuan to US dollar exchange rate had been stabilized at 8.27 for a long time after a slight appreciation during 1994~1996. Therefore, RMB was pegged to US dollar at this stage. July 21, 2005, the PBC issued a public notice, China began to implement a market-based and managed floating exchange rate regime which was regulated by the references to a basket of currencies. And at the same time, the RMB exchange rate to US dollar was one-off revaluated to 102% which marked the RMB exchange rate regime had embarked on a more flexible and more market-oriented path. Nevertheless, the choice problem of the RMB exchange rate regime still exists. And because of RMB is becoming more convertible and the pressure of RMB appreciation is reincreasing, the RMB exchange rate regime should be more flexible or more stable or even return to the fixed exchange rate regime is still very worthy to be studied.Broadly speaking, the goals of exchange rate regime are same with the goals of the government's macroeconomic policies and the ultimate goal of macroeconomic policy is to balance a country's external and internal economy. Therefore, the goal to chose the exchange rate regime is at least to some extent to realize the balance between one country's external and internal economy. Actually, the RMB exchange rate was pegged to US dollar for a long time since the 1997 Asian financial crisis to"7.21"exchange rate reform. This kind of exchange rate arrangement played a positive role in a more stable foreign exchange market and also developed the trade and attracted more foreign investments. But in recent years, the constraints of the fixed exchange rate regime on China's economy have gradually become more apparent. In this case, the undervalued real exchange rate has fairly increased the surplus of our international balance of payments and affected the independence of our monetary policies and also made the lagging development of China's foreign exchange market. After the"7.21"exchange rate reform, the current exchange rate regime is apparently promoting the independence of our monetary policies and the initiative and flexibility of the exchange rate adjustment. And the current exchange rate regime which is promoting the development of China's economy should be the optimal choice currently.Actually, China's current exchange rate regime is a combination of the"central rate"managed floating exchange rate regime and the"BBC"regime and also possesses both the property from the floating exchange rate regime and the fixed exchange rate regime. According to the latest exchange rate regimes classification(IMF, 1999), China's current exchange rate regime should be categorized to the"Intermediate Exchange Rate Regimes". In the view of the practices of many countries, with the continuous economic development and openness, some countries'exchange rate regimes transited from the traditional fixed exchange rate regime to those which have a greater fluctuation range and chose the free floating exchange rate regime finally. In contrast, other countries and territories formed a currency union or the"Currency Board"regime. From the theoretical point of view, the first generation of currency crisis theories suggested that it is hard to reconcile the contradictions between the credit expansion from government and the fixed exchange rate regime. The second generation of currency crisis theories placed greater emphasis on market expectations and government's discretionary policies and demonstrated that any adjustable exchange rate regime between free floating exchange rate regime and monetary union is difficult to sustain. As one of the third generation of currency crisis theories, the"Moral Hazard"theory stressed only the bipolar exchange rate regimes can reduce the super-risk premium to its minimum, therefore, the intermediate exchange rate regimes are not sustainable. And the"Original Sin"theory illustrated that the intermediate exchange rate regimes are not sustainable for"Currency Mismatch"and"Maturity Mismatch".Capital account, which is mainly used to record domestic and foreign capital flows, can reflect the changes about one country's assets and liabilities including the capital flows that relate to loans and investments. And opening capital account means to liberalize capital transactions. In the long run, the RMB capital account openness has its necessity: First, after the accession to WTO, China will phase out the restrictions to the Chinese businesses of foreign institutions. Therefore, foreign banks can indirectly achieve RMB and other currencies totally convertible by the pledge loan between RMB and foreign currencies thus bypass the capital controls in general sense. Second, China's rapid economic development requires the RMB capital account open. Because of the contacts between china and other countries are increasingly close, strict control of capital account will no longer adapt to the new situation of economic development. Third, China's rapid economic development and the internationalization of financial services accelerate the internationalization of RMB and the restrictions on RMB capital account will become a yoke. Finally, the openness of RMB capital account will provide opportunities for the reform of China's financial system and mechanism. Actually, the openness of RMB capital account is an inevitable result and an internal requirement of China's economic development. At the same time, the independence of monetary policies is particularly important to our economic development. Therefore, in the gradual opening process of the RMB capital account, the choice of RMB exchange rate regimes should be a process with flexibility and marketization and the final choice should be the free floating exchange rate regime. Besides, the M-F model can explain this thesis well. In addition, according to the"Covered Interest Parity"theory, we can differentiate the influences that different exchange rate regimes effecting on the independence of monetary policy in terms of the interest rate and exchange rate linkage mechanism. Because the openness of capital account and the transition of exchange rate regime are complementary to each other, the relationship between them must be well coordinated.The short-term goal of the reform of RMB exchange rate regime should make the RMB exchange rate more flexible and constantly improve the managed floating exchange rate regime. The measures include: adjust the volatility of RMB exchange rate and make the market mechanism play an important role in exchange rate's determination; reduce the proportion of dollar in currency basket and increase the proportion of non-dollar currencies in currency basket; improve central bank's intervention to foreign exchange market and strengthen the credibility of government. The long-term goal of the reform of RMB exchange rate regime is to achieve free floating exchange rate regime and adopt the"independent monetary policies plus a completely open capital account plus free floating exchange rate regime"model. To promote the reform of RMB exchange rate regime we should: first, strengthen the financial system's stability and accelerate the pace of interest rate marketization; second, improve the foreign exchange market; third, change the targets of monetary policies and establish inflation targeting regime; fourth, further adjust the growth mode of trade and upgrade the processing trade.