Arthur Kroeber
Arthur Kroeber

The way the central government is ruling its currency, the Renminbi, has changed profoundly over the past months. Economist Arthur Kroeber argues in the Brookings Institute that the rules for the currency have changed profoundly.

Arthur Kroeber:

It is clear that China has entered a new phase of currency management, and the rulebook that has worked well since 2005 must be heavily revised. Two observations inform this judgment. First, the main aims of the strong renminbi policy have been achieved. The current account surplus has been virtually eliminated, and at least one serious technical study of the currency (by Martin Kessler and Arvind Subramaniam of the Peterson Institute for International Economics), the structural undervaluation of the renminbi has been eliminated.

Second, the adoption of a 2 percent daily trading band means that, on a day-to-day basis, the renminbi rate can now be determined mainly by the market most of the time (since only at times of extreme stress do currencies move more than 2 percent in a day). This newfound capacity seems consistent with the broad aim articulated in the Communist Party’s reform agenda last November, of having market forces play a “decisive role” in resource allocation. A willingness to let the currency float more freely is also consistent with the apparent agenda to liberalize deposit interest rates within in the next two years, which implies shifting from a monetary policy that mainly targets the exchange rate to one that mainly targets a domestic money-market interest rate.

It is also clear, however, that the renminbi will not simply be left to its own devices: the float will be a heavily managed one. Mechanically, it will likely operate much like the Singapore dollar “basket, band and crawl,” or BBC system, with an undisclosed trade-weighted index target, a 2 percent daily trading band puts a limit on extreme movements and a periodic readjustment of the slope of the policy band to prevent a major misalignment of the currency emerging (as it did at the end of China’s hard-peg era).

Strategically, the two most important aims of Beijing’s exchange rate regime will be maintaining stability of both the current and capital accounts, and providing support for the emergence of the renminbi as a serious international currency.

Much more at the Brookings Institute.

Arthur Kroeber is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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