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December 30, 2005
Another necessary step to currency reform
From the beginning I've argued that China will at some point have to adopt a meaningful currency reform but that they should do it on their own timetable. It should also be pretty clear that a number of things will have to happen in a certain order. This isn't the sort of thing that you just go out and do haphazardly. For example, I posted this just a few short days before the small revaluation that happened back in July.
So what next? The answer came today via this WSJ article (subscription required).
SHANGHAI -- In another step toward more currency flexibility, China's foreign-exchange regulator approved the first batch of foreign and local banks to act as yuan market makers, bankers familiar with the matter said.
Here's what China Daily had to say:
Expectations for further appreciation of renminbi remain in the marketplace, as trading partners continued to push for a stronger yuan and complained about narrower-than-expected price fluctuations.
The introduction of market makers in transactions between renminbi and foreign currencies will likely broaden the fluctuations, but "it will only be seen after the system has worked for some time," the trader said.
China's four State-owned commercial banks, such as the Hong Kong-listed China Construction Bank, are still the biggest traders of yuan in the market after the People's Bank of China (PBOC), the central bank.
But foreign banks will play a bigger role in the future. "It will enable us to fully participate in the development of the foreign exchange market, while providing more flexibility for our clients," Richard Stanley, Citigroup's China chief executive officer, said in a statement. "We believe this is another important step for the advancement of China's currency market."
The introduction of more market makers, which are expected to provide liquidity by quoting both selling and buying prices, will also help reduce the burden on the central bank to absorb excess dollars in the market.
The PBOC enforces the trading band of renminbi by buying the excess dollars in the market with local currency. Its purchases of dollars are added to a growing stockpile of foreign exchange reserves, while the local money it uses injects new liquidity into the banking system.
With China's foreign trade continuing to see huge surpluses and expectations for a renminbi appreciation remaining strong, heavy inflows of dollars have fuelled the growth of local money supply to unhelpfully fast rates.
There will probably be a year in the not so distant future when the economic story of the year is currency reform in China. I don't think 2006 will be that year. Maybe 2007, but even that might be pushing it (of course, the Olympics are in 2008). Until then, expect a story like this every few months confirming that progress is being made.
Posted by William Polley at December 30, 2005 6:38 PM
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