A Research On Exchange Rate Risk Management Of Central Bank Under The Situation Of Capital Account Liberalization

Since the Reform and Opening up,China has been steadily promoting Capital Account Liberalization. "Central Committee Decision on Major Issues Regarding Overall Reform" approved through the Third Plenary Session of Eighteenth Central Committee of CPC notes that "Promote the convertibility of RMB Capital Account". A higher level of liberalization of capital account, as well as expanding capital flows, are bound to have a profound impact on the foreign exchange market. Under this circumstance, China Cental Bank’s Foreign Exchange Rate will certainly present new features, which poses higher requirements for monetary institutions to maintain economic stability.This article researches on the topic of Foreign Exchange Risk Management in the perspective of Central Bank, and analyses the identification, measurement and management of foreign exchange rate risks with a comprehensive framework on risk management. This article starts with an introduction of relevant theories on Capital Account Liberalization and Exchange Rate Risk Management, followed by the analysis of China’s Capital Account in current situation and estimates the liberalization indexes of capital accounts since 1998. It shows that the liberalization indexes are on a significant trend of increase, which implies that China has been releasing control on the capital market. As is shown empirically, based on the monthly data from July 2005 to June 2013 and through calculations on EMP (Exchange Market Pressure Index) China Central Bank identified the risks of supply-demand imbalance on foreign exchange market, and found that RMB appreciation pressure was present most of time. In order to soothe the situation, China Central Bank reacted to RMB appreciation pressure by increasing reserve. Subsequently, this article calculates the value at risk of China Central Bank’s Exchange Rate by means of Monte Carlo Simulation, and measures the exchange rate risks that China Central Bank are facing based on the Vulnerability Index derived from the simulation. According to the analysis, it has been found that the Vulnerability Index and Exchange Rate Risk were both low, mainly due to relatively stringent control of capital flows in China. The article is then followed by case studies of Japan, India and Chile, discussing the problems of cental banks in these countries encountered during capital account Liberalization, the strategies used to solve the problems, subsequent outcomes and what should China learn from these past cases when dealing with its own exchange rate risks. In the end, based on the theoretical analysis and empirical conclusions while taking China’s reality into account, this article advices on improvement of RMB Exchange Rate System, guidance on two-way fluctuation expectation, optimization exchange reserves’size and structure, and RMB internationalization process.