Rmb Currency Basket Empirical Research

On July 21st 2005, China moved into a managed floating exchange rate regime basedon market supply and demand referring to a weighted currency basket. This reform,also an aggressive innovation by the monetary authorities, is of great importance. By"referring to" not "pegging to" a currency basket, the government is able to activelyrespond to domestic economic situations by adopting proper monetary policies and amanaged exchange rate, instead of being passively committed to certain exchange rateparity.It's the key to decide currencies and weights under RMB basket reference regime.According to PBOC, currencies are selected and weights are assigned based on tradeweights, and with due consideration of foreign debts and foreign direct investment.Scholars and investment institutions both home and abroad are making a guess on theRMB basket, which is also the purpose of this paper. The author aims to findrationales in PBOC's reform explanations, come up with an optimum RMB basketthrough research of trade, foreign debt and foreign direct investment data, and adviseon government policies to go along with the managed floating-rate regime.The introduction part begins by summarizing key points in choice theory of exchangerate regime and then analyzes the characteristics and influence of the current managedfloating rate regime. After illustrating the purpose of the paper, this part also evaluatesits innovation and explains the research method.Chapter 1 deals with literature review in the field of currency basket. This part beginsby introducing theories and research worldwide on pegging to a basket of currencies.Then the author summarizes and comments on findings concerning RMB currencybasket. The author also explains quantitative models built by previous research, with akey on the policy goals and how to assign currency weights.In Chapter 2, the paper introduces a quantitative model to determine the optimumweights for basket currencies. The author chooses 13 currencies of China's majortrade partners, and calculates currency weights based on factors of trade, foreign debtsand foreign direct investment. The part also illustrates the econometric tests toexclude certain currencies from the basket.In Chapter 3, the paper analyzes the above-mentioned 13 currencies and calculates assigned weights using trade, foreign debts and foreign direct investment data. Empirical results reveal that RMB basket is composed of 9 currencies. A positive correlation of 0.9 proves that this basket is a very close estimate of the currency basket referred by RMB.In Chapter 4 the author puts forward relevant recommendations. The government can get inspiration from Singapore and focus on the support of the whole macroeconomic system. Specific measures can be taken, like enhancing the flexibility of exchange rate regime, encouraging the reform and innovation in financial and foreign exchange markets, improving PBOC's market intervention and carrying out supplementary monetary and fiscal policies.In the last part the author summarizes key points in this paper. Conclusion is the 9-currency basket built in this paper is a good estimate of RMB. Here is what the paper can add to previous work in the field of building currency basket. First, a majority of research only considers the factor of trade, and thus USD weighs over 60% in the basket. This finding reveals that if we only consider trade, then the reform makes no significant difference since the basket is much like RMB pegging to USD and can't completely reflect RMB equilibrium exchange rate. So the paper considers trade as well as foreign debts and foreign direct investment, and offers an idea of Asian currencies' relevance on RMB. Second, previous research doesn't appeal to foreign exchange market data to examine currency baskets they build. The paper analyzes correlation between RMB and basket and confirms the rationality of this basket.