Chinas Exchange Rate Regime - Case Study Example

0 China’s Exchange Rate Regime 1 Exchange Rate Regime Finance and policy planning as an important function carried buy every country for the purpose of economic development and planning. A country lays down its macroeconomic policies with an aim of planning for the use of resources in the country to increase the GDP and its overall position internationally (Goldstein 56). One of the things that macroeconomic policies address is in a country is the exchange rates regime, which enables it makes a reserve of foreign exchange deposits and for the ease of international trading. A foreign exchange rate regime for a country describes the way an authority creates an effective management strategy for its currency against those of other countries; this is usually carried out on the Forex market internationally. Forex market regimes are similar to a country’s monetary policies; in addition, the two systems are affected by similar factors in their efforts to achieve set macroeconomic policies for a country. This paper discusses the implications of the recent China’s foreign exchange rate regime that has been development in the wake of rising concerns over its seeming protective exchange rate regime that has been in use for a long time. 1.2 Types of exchange rate systems In many countries, there are two main types of exchange rate systems, the floating as well as the fixed exchange rate systems, in the first one, the market is the dominant force, here; it dictates movements experienced in the rates used to determine how currencies exchange. There is also the pegged float, which is part of the floating system where the central bank takes the responsibility of keeping the rate away from deviations that may be far from the targeted band or certain value in the Forex market. In the fixed exchange system, one currency is tied to another country’s currency in a fixed or a relatively permanent position, it only applies to currencies that used worldwide, for instance the American dollar, euro among other currencies. 1.3 China’s exchange rate regime In the recent past, the exchange rate policy in China has risen to become a central of concern internationally, in this regard; several matters deemed to be contentious about the regime have been identified as salient, having worldwide ramifications. Renminbi’s exchange has so far stood as the central factor that has prompted worldwide concerns of china’s regime. However, what continues to stand as a disputable issue is whether renminbi is actually undervalued, in this understanding, there has been a unanimous consensus that the exchange rate regime in China needs to have an overhaul to give room for increased flexibility. In the recent past, china’s currency is said to have been pegged on the American, this meant that China’s government had to have a strict regulation for the level as well as variability over the exchange rate that was being fronted by its renminbi. In this development, it was observed that the market forces were outrightly denied to operate in the country’s economy. In fact, this move played a huge role in the misalignment of the renminbi, something that prompted a domestic and international cry for the country to overhaul its exchange rate regime. Value of the Yuan in comparison to other world currencies in 2005-2007 Source: Frankel and Wei (8) 1.4 The current form of China’s exchange rate regime Following huge inefficiencies that were witnessed in the Renminbi’s exchange rate system, policy planners were forced to device ways of reforming China’s exchange rate to be in tandem with other systems in the world. This was informed by the fact that the previous regime was rigid, denied market forces the ability to determine currency movement in relation to those of other countries. Extensive research and macroeconomic planning later brought the change that was highly anticipated in the exchange rate regime of the Republic of China; however, some explained that the announcement was merely an issue of intent as opposed to a roadmap designed for the country’s future policy. Details about the new policy regime have continued to remain quite scanty, but it is certain that the country is soon bringing back the a crawling peg system that was in existence in 2005-2008. During this time, it is recorded that the there was a set parity that was fixed at 6.83/USD, in the three years that followed consecutively, there was general flexibility in country’s Forex market, through which china’s Yuan is recorded to have had a significant gain of 21% to the USD, which lost 8% in comparison to the euro. Currently, the Forex market in china reveals a modest form; there is an estimated appreciation of 3% that is to happen in 12 months compared to the dollar following the NDF (Non-Deliverable Forward) contracts that have been put in place. Adapted from:Goldstein and Nicholas (145) How the currency operates The new exchange rate regime is set be operated by the PBoC (People’s Bank of China), in its new phase, the bank will give room for a +/-0.5% trading band that will be available on daily basis. As the movements will begin to prevail, there will be a reflection of the wider basketful of other worldwide currencies, especially for those that are in line with china’s main partners in international trading. In this regard, some of the major currencies that will be interacting with this new system include the Japanese yen, American dollar, the euro among many others that the new system will allow. PBoC seems to be very aggressive in its push and implementation of this system, the bank of fronting the introduction of a double-sided risk with an objective of dissuading any speculations being made about the country’s currency and the effectiveness of the system (Frankel 234). It is important to note that for now, the success of this strategy continues to remain a big guessing game among concerned stakeholders including policy planners and the people of the republic of China 1.5 Reason for change of regime In the recent past, it is recorded that the has been a huge outcry from policy makers in European countries as well as those in the United States of America. They had complained of constant frustrations that were being witnessed as a result of the exchange rate regime that was in place in China. Cumulative Complaints by US Treasury and other Government Complaints Source: Frankel and Wei (52) In fact, the US congress was on the verge of announcing China as a currency manipulator, it is believed that treasured played an essential role towards this move by delaying a session paper that would have been used by the Congress to advance their claims. China, sensing the probability of straining its relationship with the US and other trading partners made efforts to change its exchange rate policies to be in tandem with those of its key trading allies. The price of Non-Deliverable Forwards NDFs around the Time Official US pressure began Source: Frankel and Wei (4) Politics and diplomatic interventions are said to have come in handy, influencing the timely announcement for a change of the exchange rate regime, however, it is believed that there was a huge basic economic reasoning behind the move and not just politics. In future, it is believed that china’s trading allies will continue to push for increased re-evaluation of the new regime in order to create a mutual trading ground for all parties involved. The parties that are deemed to reap big in terms of benefits from the re-evaluation will be Asian trading allies, who are said to trade in volumes with China. 1.6 Benefits and risks of this move to the development of China The macroeconomic move that has been put in place by china’s policy makers is said to have many benefts to the country as well as its trading partners. However, the risks to this move may happen if it later happens to become innefective. The move has been described as placing China in a very unique positions since such a move is rarely inneffective. In this case, the PBoC will have a good opportunit to fix the exchange rate effectively while at the same time carrying out its monetary policies independendly. For most move is always not common with most large economies, this is because, their central banks are forced to establish a monetary anchor as well as different nominal exchange rates, which is not the case with China. The Country is deemed to have a great amount og control on capital flow, this will enable PBoc to frequently make adjustments to its nominal rates for general developement of the country’s economy. Just like it happens in other countries, the growth of the GDP can be managed by having an undervalued exchange rate, at the same time, the rates of inflation can also be put to check through increasing the rates of interest and putting controls on tha banks’ lending rate. China happens to be beyond the development phase whereby this approach can be termed as holding any advantages. It is imperative to point out that capital controls in an economy, underdevelopments in the financial markets as well as sterilization operations are all causes of distortions. In addition, they results in inefficiencies in of resources in the wider economy, at the elementary levels, these processes are often minorare easily offset by advantages brought about by an inflation–free growth that is export-led. When these distortions are not dealt with, they can grow to cause huge disruptions in a country’s economic growth by being an obstacle to effective policy implementation. The move by China is set to give it many opportunities to grow and expand its economy, first, instead of putting up a whole $2.5 trillion for investing in assets that are low-yielding, the country will chose to devote those resources in the process of improving the livelihood of its citizens (Whalley 356). This move will also boost the capacity of human capital as well as its safety net, thus leading to increased prospects for economic growth and development. Secondly, the financial systems in China are owned by the state completely, this economic move is aimed at liberating the financial sector, to allow it to move according to market dynamics as it is the case with other large world economies. By introducing this economic move, there will be privatization of the country’s banking sector, something that will enable it improve its allocative efficiency. In this move, more resources will be created and made available for many other productive uses, thus increasing its GDP and general economic growth and development. 2.0 Exchange Rate Regime’s Ability to Handle Curent and Future Situations Market implications By putting the existing 12-month market prediction of an appreciation of 3% in perspective, china’s economists have estimated that the country’s Yuan will need a single re-evaluation of approximately 15-25% in order to bring back its equilibrium level effectively. In this case, the move will signal an undermining of the 3% expected appreciation; however, something of concern is that the Yuan will be expected to experience an approximate appreciation of about 7% annually in the process of keeping in tandem with rising purchasing ability of China with reference to past trends as shown. Adapted from: Goldstein and Nicholas (148) 2.1 Investment implication The new exchange regime in china can be said to be having a minimal immediate consequence, however, in the long-run, the risks that had been brought by the passing of the protection measures in the US Congress will automatically decline. This move will be welcomed with loud cheers for this people involved in risk assets, since the chances of losing on their investments will be minimal. With the passing of time, the country will witness many stronger positive implications. China, as a powerful in the region country, poses a great influence on other Asian countries, in this case, there is bound to be a similar appreciation of these countries currency, with the objective of creating economic advantages like china, for instance, Malaysia and South Korea. 2.3 Effect of China’s exchange rate regime to the United States The effect of China’s exchange rate regim to other countries and America in particular is all about the purchasing power that is being created. The new exchange rate in China can be termed as its main expenditure policy that it hopes to use in order to establish itself as a supoer power and leading world economy. It is estimated that in the past decade, PBoC has been successful in ammassing a whooping $2.5 trillion in terms of its purchasing power, this way it has managed to keep away domestic and low-risk borrowes from the United States as shown (Wong 248). Following this move, China, thoruhg its PBoC managed to export its new found wealth and purchasing power to most of the large economies including the United States. Following this move, politicians in the United States and oher European countries have been on the forefornt to puch for China to redirect its purchases power towards their own goods and services instead of their assets. Many other large economies including the United States have felt threatened by China’s bold move to leverage its economy, for this reason, they are opting for alternative ways of curtailing china’s emerging economic superiority. Adapted from: Goldstein and Nicholas (156) Works Cited Frankel, Jeffrey. New Estimation of Chinas Exchange Rate Regime.Cambridge, Mass.: National Bureau of Economic Research, 2009. Print. Frankel, Jaffrey and Wei, Shang-Jin. Assessing China’s Exchange Rate Regime. 2007. Web. 1 October 2014. < http://www.nber.org/papers/w13100.pdf> Goldstein, Morris and Nicholas Lardy. The Future of Chinas Exchange Rate Policy. Washington, DC: Peterson Institute for International Economics, 2009. Print. Goldstein, Morris. Debating Chinas Exchange Rate Policy. Washington, DC: Peterson Institute for International Economics, 2008. Print. Whalley, John. Chinas Integration into the World Economy.Singapore: World Scientific, 2011. Print. Wong, John. Chinas Surging Economy Adjusting for More Balanced Development. New Jersey: World Scientific, 2007. Print. Read More