Governor of the People's Bank of China Zhou Xiaochuan made responses on issues such as the exchange rate of the Chinese currency Renminbi (RMB) and China's trade balance during an interview with Xinhua recently. Following are the questions and Zhou's answers:
Question: What do you think of the fixed exchange rate of the RMB, a question Mr. Horst Kohler, managing director of the International Monetary Fund (IMF) and Mr. John Snow, treasury secretary of the United States raised during their recent visits to China?
Zhou: China's current unified, managed floating exchange rate regime based on market supply and demand of foreign exchange came into existence in 1994. Between 1994 and 1997, the exchange rate of the RMB against the US dollar appreciated from 8.7:1 to 8.3:1, reflecting the feature of a managed float regime.
At the end of 1997, at the request of neighboring economies and international institutions, China substantially narrowed the floating band of the RMB exchange rate to help reduce the shock of the Asian financial crisis and dispel the fear of RMB devaluation. The narrowing of the band should not be seen as a change from float to fixed regime. China would consider resuming its original band and improving the formation mechanism of the RMB exchange rate if there were such a consensus in the region, recognizing that the Asian crises had been over and their related problems had been solved. However, views on this issue are different, and many neighboring countries and economists believe that it is not the right time to make such a move.
Question: Will China continue to maintain large trade surplus and high foreign reserves growth?
Zhou: As a central bank, we are clear that the Chinese government does not pursue trade surplus, but rather aims at a roughly overall balance in the current account. It is also a policy followed by the Ministry of Commerce, and the intention of this government as well.
The government does not pursue rapid growth of foreign exchange reserves. Since China recorded limited foreign reserves in the 1990s, it was necessary to expand them to be compatible with the level of import and external debts. The outbreak of the Asian financial crisis in 1997 led to reconsideration of the appropriate level of foreign reserves among Asian countries and a higher level was thought to be desired. China's foreign exchange reserves have recovered to an adequate level and are no longer expected to grow at a high rate. With continuous expansion of import and export and capital inflows to China, we would be comfortable to have a moderate growth.
Question: Will China be able to achieve a rough overall trade balance as a policy objective?
Zhou: It is difficult to predict whether China will record trade surplus or deficit. Unlike many other countries, China is in a stage of overhaul of its trade regime. It was not until the end of 2001 that China was accepted as a member of WTO, which entailed a series of trade reforms. At that time, many people predicted that China's import would surge and exceed potential growth of export as a result of substantial reduction of tariff and non-tariff measures, including import quota and further opening up of service sector. It turned out that while China's import in 2002 recorded a rapid expansion, export also surged, resulting in a trade surplus of US$30.4 billion.
In the five years following the accession to WTO, China will continue to cut tariff and relax quantitative import restrictions, further liberalize service trade, including financial and communication sector. All these will increase the difficulty to forecast current account balance. Since the beginning of this year, the growth of China's imports has accelerated, surpassing that of exports. In the first half of this year, China's trade surplus reduced to US$4.5 billion. Estimates generally show that the growth of imports will be approximately nine percentage points higher than that of exports this year. With a trend of imports outgrowing exports, China's trade will balance in a year or two. Based on this trend, it is too early to judge whether the RMB exchange rate is undervalued or overvalued. Therefore it would be unwise to make exchange rate adjustments on such grounds.
Question: Is it possible to address Sino-US trade imbalance by means of exchange rate?
Zhou: It is known that a country's exchange rate is related with its balance of payments. However, it depends on the country's overall trade balance rather than on bilateral trade balance. Bilateral trade balance may be affected by structural, policy and other factors. International trade theories and WTO spirit call for multilateral-trade balance rather than bilateral trade balance.
Given the two countries' existing economic and trade structure, the United States would continue to have big trade deficit with China, even if China achieved an overall current account balance through changes in trade and currency policies. The US trade deficit may be attributable to structural imbalances and fiscal deficits in the United States rather than the RMB exchange rate.
Question: Will China take more of developments of the world economy into account when setting its policies?
Zhou: China's policy making is mainly based on its domestic conditions, but also takes into account the regional and global economic conditions. In short, since China is still a developing country, its impact on the world economy, particularly the effect of China's trade development on other countries' economy and employment should not be exaggerated.
The US dollar has weakened since the beginning of this year. In our view, China might have been informed of its intention in advance if such a weakening were designed to address the trade imbalance between the United States and other countries and regions, particularly its deficit with China. All we knew at that time was the United States would continue its strong dollar policy, and it was only some time later we came to realize that the US dollar was actually allowed to fall. Therefore, it is groundless for certain people to accuse China of non-cooperation with the United States in adjusting its balance of payments. How could we cooperate without being informed of its intention? In fact, the United State knew all along that the central exchange rate of RMB is set based on the US dollar, and it should not be surprised to see the Sino-US trade unaffected by the weakening of the dollar. As for whether the RMB central rate should be formed against the dollar or a basket of currencies, that would be a different issue, which we would be willing to discuss.
Question: What has China done so far to improve its balance of payments?
Zhou: With a trade surplus and fast increase of foreign reserves, China has been adjusting policies that may affect its balance of payments and has taken the following steps to further open up to the rest of the world.
QFII (qualified foreign institute investor) was introduced last November.
The policy to launch QDII (qualified domestic institute investor) has been under consideration for some time. Although its implementation will largely depend on a consensus, the discussion per se is a positive sign of moving forward.
-- China is implementing the policy to encourage all kinds of Chinese enterprises to invest and do business abroad, and relevant procedures on investment, exchange and remittance have been simplified.
-- Foreign-funded enterprises have been allowed to raise funds in the domestic capital market. We welcome foreign investment in China. However, the investment is not necessarily to be dominated in foreign exchange. RMB equity financing in China is feasible, if it is needed.
-- International financial institutions have been permitted to issue RMB bonds in domestic market. -- Multinational corporations have been allowed to consolidate operations of foreign exchange resources of their subsidiaries in different locations in China.
-- To facilitate travel abroad, restrictions on foreign exchange purchase by the Chinese travelers have been relaxed with the indicative limit increased by 2.5 to 3 folds. Extra consumption expenditure can later be satisfied with late purchase of foreign exchange.
-- The procedures for travelers to carry foreign exchange out of China have also been simplified.
-- Domestic assets of emigrants and non-residents can be exchanged into foreign exchange and repatriated. In the past, only earnings of the stock, real estate and equity investment could be changed into foreign exchange and repatriated. We are now working on the operational procedures for asset transfer.
-- The restrictions on opening of foreign exchange account by enterprises and the limit on account have been eased since 1994 when the foreign exchange reform was introduced. This relaxation process was only temporarily halted during the Asian financial crisis, and now is back on track.
All these measures, designed to make exchange under current account easier and to liberalize excessive restrictions on capital account transactions, will serve to improve China's balance of payments. China will continue to lift foreign exchange control to balance trade, and gradually make the RMB a convertible currency, an objective set at the Third Plenary Session of the Fourteenth Congress of the Communist Party of China (CPC) in 1993. Of course, we understand it will take a relatively long time.
Question: Is there any specific plan to improve the formation mechanism of the RMB exchange rate?
Zhou: The reform of the formation mechanism of the RMB exchange rate is an important item on the agenda of China's overall foreign exchange reform. Broadly speaking, the current RMB exchange rate is set based on market demand and supply of foreign exchange, with necessary intervention to smooth large fluctuations in the market. With the role of the market becoming increasingly important, the exchange rate of the RMB will be finally determined decisively by the market forces and have great flexibility.
With reforms on many fronts unfinished, prioritization, sequencing and complementality of reform measures remain critical to success of exchange rate regime reform. A few things need to be accomplished before adequate flexibility can be introduced in the exchange rate regime.
First, trade, in particular service trade, is to be basically liberalized.
Second, excessive, although not all, restrictions on capital account transactions are to be removed so that the market forces will play the decisive role.
Third, the reform of China's state-owned commercial banks has to make substantial progress with major problems being basically solved. In fact, we have started to reform the state-owned financial institutions to prevent systemic risks and enhance their competitiveness since all foreign-funded financial institutions will be permitted to conduct RMB business by 2006 and their market access will be substantially broadened as well. Strengthening competitiveness and risk prevention mechanism will help pave the way for the state-owned commercial banks to be viably responsive to the new exchange rate regime.
The above three items are relatively high on China's overall reform agenda. They must be properly resolved before reform of the formation mechanism of the RMB exchange rate could be carried out in great stride, though there could be some flexibility with the sequencing.
Question: Is it possible to take an earlier action?
Zhou: We do not consider a narrow float regime against a single foreign currency the best choice. In our view, it largely depends on a country's unique situation, and may require change with time and circumstance. Given the size and development stage of the economy, the prevailing exchange rate regime has worked quite well. Of course, it also needs to be gradually improved. Recently, the speculative talk about revaluation of the RMB has induced some "hot money" into China. This kind of speculation is not to be encouraged, for there is too much "hot money" in the world and they would probably continue to sneak into China if vigilance is unduly relaxed. Therefore, with a view to discourage "hot money" speculation, it is wise to re-endorse stability.
Some people fear that China might have inadequate instruments to sterilize the inflow of "hot money". I should stress here that the central bank has the capability to sterilize the liquidity impact of inflow of "hot money" with additional monetary policy instruments. The recent rise of reserve requirement ratio was a clear signal that the central bank was ready to sterilize the inflow and did not hope to see further increase of "hot money". This kind of speculation is very likely to fail.
Question: Would a change in China's exchange rate regime in the future improve Sino-US trade situation?
Zhou: It is difficult to assert whether balancing China's trade or current account by changing exchange rate regime would lead to smaller US trade deficit with China. Some structural analysis might help. In particular, to what extent would the imports from China compete with or replace the same type of products made in the United States? The United States is strong in high-tech products and service export. For example, there are substantial exports from the United States to China in the area of transportation, communication and finance and its high-tech products are most welcome in China. Whether all these advantages could be brought into play does not necessarily depend on the level of exchange rate. If we only focus our view on general commodity trade, we are likely to miss the whole picture. Take Japan as an example, the Japanese Yen against the US dollar experienced a persistent appreciation from 360:1 to 250:1, to 100:1 and even to 79:1 at its peak. For the time being, it stands at 116:1. What has been the impact of the exchange rate of Yen on the US-Japan trade balance? Some people believe that the exchange rate elasticity of commodity trade is quite limited, though it does exist, and commodity trade relates more to production structure and the existing division of labor.
Question: Could you comment on the concern expressed by some people about exchange rate impact on employment?
Zhou: Some people even relate the loss of jobs in some developed countries to RMB exchange rate. We all know employment is somewhat politicized as low employment rate affects election. In our view, each country has to face the issue of employment in its presidential election and what we need to do is to identify first domestic causes for the job losses. In fact, China faces the biggest pressure of employment in the world since it has to create10 million jobs each year. In particular, China has a large rural population. A revaluation of the RMB would result in a decrease of competitiveness of some of China's agricultural products. It is known that China is a country with large population but limited arable land. The agricultural sector is labor-intensive and low in productivity. If an adjustment of the RMB exchange rate made China's staple agricultural products unable to compete with imported ones, and thereby force farmers, especially those in the coastal areas to leave farm land for cities in a much faster speed, the employment pressure would be more acute in cities since they have to provide more "non-farm jobs". A one-percentage-point fall in agricultural employment means a loss of around four million jobs in the farming industry. Many people only focus on the impact of exchange rate adjustment on export and employment, in fact, the pressure is more heavily felt on agricultural imports and migration of agricultural population. Both text books and international experience show that unemployment, particularly in large countries, can be most effectively addressed mainly through structural reform, including the improvement of labor skills to adapt to international competition. Trying to divert attention and pressures would not help solve the problems.
(Xinhua News Agency October 19, 2003)
