Thursday, July 21, 2005
This move constitutes a compromise between various domestic forces, but I am afraid
that it will nonetheless trigger a resurgence of hot money flowing into China. A couple of weeks ago, Chen Xiwen said to the SCMP that the reluctance to revaluate stems to a large extent from Wen's fear that farmers will further lose the incentive to produce grain as increasing Chinese purchasing power allows foreign grain to flood the Chinese market. Also, doemstic industries are always complaining about rising import. Finally, coastal regions are afraid that a steep revaluation will decrease China's competitiveness edge. A 2% revaluation should not have much of a direct impact on all of those fronts, though if I were a farmer, I would switch out of grain production in expectation of further rise in the RMB.
Why should we expect more hot money? The revaluation was much below analysts expectation (which ranges from 5-20%), so the expectation is that there will be more movement. Once credibility has been lost, it will take some time to re-establish it. In the mean time, the PBOC will have to accelerate money sterilization. Moreover, it's not that we have no information about the new basket peg; we know that it isn't composed entirely of dollars (at least in principle) anymore. If the dollar rises further, it is true that the RMB won't have to revaluate along side the dollar.
But is that what we really think the dollar will do in the second half of this year? Sure, the dollar enjoyed a spectacular run during the first half, but will that continue? Will Bush's "declining deficit" continue as the war in Iraq drags on with no end in sight? If the dollar declines, we know that the Chinese no longer has to follow--this is vital information that should bolster investor expectation of a further revaluation of the RMB against the dollar.
BEIJING, JULY 21-- The following is the full text of the announcement published on the central bank’s website (www.pbc.gov.cn):
Public Annoucnement of the People's Bank of China on Reforming the RMB Exchange Rate Regime
July 21, 2005
With a view to establish and improve the socialist market economic system in China, enable the market to fully play its role in resource allocation as well as to put in place and further strengthen the managed floating exchange rate regime based on market supply and demand, the People's Bank of China, with authorization of the State Council, is hereby making the following announcements regarding reforming the RMB exchange rate regime:
1. Starting from July 21, 2005, China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB will no longer be pegged to the US dollar and the RMB exchange rate regime will be improved with greater flexibility.
2. The People's Bank of China will announce the closing price of a foreign currency such as the US dollar traded against the RMB in the inter-bank foreign exchange market after the closing of the market on each working day, and will make it the central parity for the trading against the RMB on the following working day.
3. The exchange rate of the US dollar against the RMB will be adjusted to 8.11 yuan per US dollar at the time of 19:00 hours of July 21, 2005. The foreign exchange designated banks may since adjust quotations of foreign currencies to their customers.
4. The daily trading price of the US dollar against the RMB in the inter-bank foreign exchange market will continue to be allowed to float within a band of 0.3 percent around the central parity published by the People's Bank of China, while the trading prices of the non-US dollar currencies against the RMB will be allowed to move within a certain band announced by the People's Bank of China.
The People's Bank of China will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation. The RMB exchange rate will be more flexible based on market condition with reference to a basket of currencies. The People's Bank of China is responsible for maintaining the RMB exchange rate basically stable at an adaptive and equilibrium level, so as to promote the basic equilibrium of the balance of payments and safeguard macroeconomic and financial stability.
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