Impact Analysis Of Interest Fluctuation On RMB Exchange Rate

Based on the review of theoretical dissertation on the relationship between interest and exchange rate and China's market-oriented reform in its interest and exchange rate market, this paper established static and dynamic regression model with interest difference and exchange rate difference to test the impact of interest-parity in the forward pricing of RMB. Regression results show that short term contracts are more affected by interest-parity than long term contracts. Furthermore, this paper studies the dominance of offshore and onshore RMB forward market by establishing dynamic regression model and vector error correction model, both models show that onshore RMB forward market is still under the impact of offshore market. In addition, offshore NDF market is more sensitive and effective in terms of the information flow efficiency from interest to exchange rate. Finally, this paper tests the impact of benchmark rate on exchange rate through event test. Test results show that only spot rate is affected by the signaling of benchmark rate adjustment, forward exchange rate might overdraft the signaling effect through market expectation.Based on the above empirical tests, this paper finds out that after the market-oriented reform in both the interest and exchange rate markets, interest-parity began to play certain role in the forward pricing of RMB, but in longer-term contracts, the pricing still can't get rid of other factors like market expectation, which is the result of the immature relationship between interest and exchange rate market. Such derail from interest parity will first bring out arbitrage opportunities and lead to false expectation of RMB value, which will exacerbate the volatility of the RMB forward market. On the other hand, the RMB forward pricing in domestic interbank market still has not yet broken away from the impact of the offshore NDF market. Along with the expansion of the trading volume in NDF market, the forward pricing right of RMB will inevitably be at stake as well if corresponding measures are not taken. Meanwhile, the short term signaling effect on spot exchange rate from central bank's adjustment of benchmark interest rate shows that under the current exchange rate policy, central bank has to take the controllability of the exchange rate market and its impact on the huge foreign reserve into account when adopting monetary policies.