Toward the Soft Landing of the Yuan Market

ABSTRACT

With January 1994's renminbi yuan rate standardization and December 1998's foreignexchange market consolidation, China is moving ahead in the transition from foreign exchangecontrol to a free-market system. Despite the Asian currency crisis and other major changes inexternal and internal economic conditions, the renminbi yuan rate is being maintainedartificially, without regard to market supply and demand.

With the ostensible liberalization of ordinary items in China's foreign exchange system, a"controlled floating rate system based on market supply and demand" has been initiated in theforeign exchange market. Nonetheless, the renminbi yuan market is being controlledartificially, through limits placed on foreign currency demand and supply and a band around therenminbi yuan's exchange rate. Such a distorted foreign currency market structure makesforeign currency control increasingly difficult and prevents the exchange rate from functioningas a means of international payment adjustment. The Asian currency crisis has once againunderscored the limits of China's policy of foreign currency control.

From the standpoint of assessing the cost performance of foreign currency control and bringingout its international payment adjustment functions, the transition to a floating rate system is thebest choice both for China and the rest of the world. Constructing a foreign exchange marketthat is competitive and which fully reflects supply and demand will require 1) abandonment ofthe policy of restricting foreign exchange demand in the foreign exchange market, 2) the easingor elimination of the forced settlement system, and 3) the easing or elimination of the positioncontrol of foreign exchange-designed banks, among other measures.

The transition to a floating rate system is expected to 1) assure independence in macroeconomicpolicymaking, 2) be conducive to WTO membership, 3) promote reform of the domesticeconomic structure, 4) reduce the government's budgetary burden, 5) lay the groundwork forthe liberalization of capital transactions, and 6) have such policy effects as improving theexternal transparency of China's economic policy.

In view of such factors as foreign currency reserves and external debt, the problem of foreigncurrency introduction and external debt are not major impediments to renminbi yuan marketadjustment. Also, in terms of maintaining the Hong Kong dollar peg, China's political stabilityand economic development are more important, rather than renminbi yuan market itself.

Introduction

Conclusion