Monetary and Exchange Rate Policy in China: Fallacies and Rules

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Monetary and Exchange Rate Policy in China
Fallacies and Rules

• Xingyuan Feng
• Vice President
• Cathay Institute for Public Affairs, Beijing
• Email fengxingyuan_at_gmail.com

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Structure

• 1. Institutional deficiencies
• 2. Monetary policy fallacies and rules
• 3. Exchange rate policy fallacies and rules
• 4. Desirable combination of monetary policy and
  exchange rate regime

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Structure

• 1. Institutional deficiencies
• 2. Monetary policy fallacies and rules
• 3. Exchange rate policy fallacies and rules
• 4. Desirable combination of monetary policy and
  exchange rate regime

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Central Committee of CCP
State Council
Leading Group of Finance and Economy
Peoples Bank of China
Monetary and Exchange Rate Policy Decision Making
Organs Institutional Deficiency
State Administration of Foreign Exchange
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Central Bank Lack of Independency

• Lack of independency in
• Personal affairs
• Institutional dimension
• Budget
• Functions
• Goal
• To preserve the stability of the value of the
  currency, and push forward economic growth in
  this way

?Monetary policy is dependent of administrative
discretion
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Structure

• 1. Institutional deficiencies
• 2. Monetary policy fallacies and rules
• 3. Exchange rate policy fallacies and rules
• 4. Desirable combination of monetary policy and
  exchange rate regime

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Inadequate base rates

• Base deposit rate a. deposit reserve rate b.
  excess reserve rate
• Base borrowing rate refinancing rate
• Discounting rate
• Doesnt use Shibor (Shanghai interbank offered
  rate, available since April 1, 2007) as base rate

• ??Euro zone
• EURIBOR (Euro Interbank Offered Rate)
• EONIA (Euro Overnight Indexed Average)

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Interest rate marketization is lagging behind

• Central banks controls 29 kinds of interest rates
• Unified deposit rates of commercial banks
• Fixing baseline rates of commercial banks
  lending
• Fixing the ceiling of lending rates of rural
  credit cooperatives (RCCs)
• Ceiling of lending rate in informal finance

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Other monetary policy transmission channels

• Open market operation (treasury bonds, bonds,
  central bank bills, foreign exchange)
• State owned commercial banks (the Big Four)
• presidents of SOCBs have minister rank
• huge ability of boosting money supply (through
  deposit creation)

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Dirigisme in credit policy

• National Development and Reform Commission
  (Formerly planning commission), Peoples Bank of
  China and China Banking Regulatory Commission
  dictate together credit policy
• Restriction in loan disbursements against
  excessive competition or repeated
  construction
• Macrocontrol (indeed micro-control)

In a market economy, credit policy is primarily
the matter of financial institutions themselves!
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Structure

• 1. Institutional deficiencies
• 2. Monetary policy fallacies and rules
• 3. Exchange rate policy fallacies and rules
• 4. Desirable combination of monetary policy and
  exchange rate regime

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Administration of Foreign Exchange

• State Administration of Foreign Exchange
• subordinate to State Council, but
• administrated by PBC on its behalf
• China Investment Corporation
• takes charge of investment to preserve or even
  increase the value of the foreign reserve

• Exchange rate policy is dependent of monetary
  authority, backed by the State Council
• Monetary policy and exchange rate policy
  decision making are mixed up.

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Exchange rate regimes

• 1994 Merging FEC (Foreign Exchange
  Certificate) and RMB
• 1994-June 2005 Dollar peg
• June 2005 Secret currency basket peg
• Till 2007 Compulsory sell by companies of
  foreign exchange to the state
• From 2007 Loosen the control of compulsory
  sell of foreign exchange

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Nature of foreign exchange reserves and fallacy
in their use

• Accumulated at the cost of supplying the
  equivalent base currency RMB
• Not governments currency asset, but the peoples
• Fallacies
• Injection into the SOCBs (?de facto department or
  manager owned)
• Investment abroad through a SOE, China Investment
  Corporation (?moral hazard)

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Foreign Exchange and Gold Reserves
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Correlations between foreign exchange reserves,
money supply and CPI
forexForeign exchange reserves m2M2 Money
Supply cpiconsumer price index (19 observations,
1990-2008)
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Exchange Rates
Equivalent to 100 RMB
In log scale
Merging FEC and RMB rate in 1994
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Secret basket peg
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Control of capital flow sale and purchase of
foreign exchange

• For individuals voluntary sale and purchase of
  foreign exchange (with strict purchase
  restriction)
• Under current account quota-related voluntary
  sale and purchase of foreign exchange (with
  strict purchase restriction)
• Under capital account compulsory sale and
  purchase of foreign exchange

?Major cause for the increase in foreign
exchange reserves
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Double surplus in China

• Current account surplus
• Capital account surplus
• FDI 2007 74.8 billion USD (USA 3.5)
• FDI 2008 92.3 billion USD
• FDI 1979-2008 852.4 billion USD

In billion USD
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RMB Convertibility

• Limited
• Accelerated
• Swap
• Made convertible in some border areas

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Structure

• 1. Institutional deficiencies
• 2. Monetary policy fallacies and rules
• 3. Exchange rate policy fallacies and rules
• 4. Desirable combination of monetary policy and
  exchange rate regime

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 The Impossible Trinity
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Practice of the Central Bank
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Desirable directions in exchange rate policy and
capital flow
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Desirable international monetary system order in
long run

• In short and mid term
• USD remaining the position as major foreign
  exchange reserve
• In long run
• Competition among currencies as foreign exchange
  reserves
• USD, Euro, JPY,GBP
• RMB after its internationalization
• Asian Single Currency for Southeast and South
  Asia (?, or Asian Monetary System?)
• Larger amount of SDR based on a larger currency
  basket

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Thanks for your attention!