Rmb Exchange Rate Case Study

There are several events regarding China’s exchange rate reform. Arguably, the first step happened in 1994. Before 1994, RMB exchange rate was overvalued, marking at 1.5 Chinese yuan/ US dollar in 1978. Then, the Chinese government implemented several measures to directly depreciate the currency and introduced dual-track exchange rate, ensuring that RMB exchange rate could reflect market mechanism and approach equilibrium exchange rate. Later on January 1, 1994, PBoC declared the unification of official and market RMB exchange rate. The exchange rate was at RMB 8.7/USD under a managed float regime. On July 21, 2005, the Chinese government decided to reform its exchange rate system, changing from the fixed rate to a managed floating rate regime.

These reforms increased the flexibility of RMB exchange rate. The RMB nominal exchange rate appreciated 21% against US dollar from 2005 until mid 2008, and the RMB real exchange rate appreciated 16%. The 2008 global financial crisis caused the authorities to limit the fluctuated range of RMB exchange rate and the RMB exchange rate was kept around 6.84 for two years, and then it was pegged to US dollar again. In 2010, PBoC once again reformed the exchange rate, and from that moment onwards, the RMB exchange rate continuously appreciated against dollar. Then in 2012, the fluctuation range was increased from +/-0.5% to +/-1% per day and increased to +/-2% in 2014 . According to PBoC, expanding the trading band aims to encourage exchange of RMB, increasing its two-way fluctuation flexibility and improving the market-based managed floating exchange rate regime. Chart 3.6 below illustrates the RMB exchange rate trend from year 2004 to

The mechanism takes the closing rate of the previous day, the demand and supply of the foreign exchange rate market, and the exchange rate of the world’s major currencies into consideration. After the announcement, the offshore RMB spot rate against US dollar drastically decreased by 1.87%. However, this fall should not be interpreted as normal currency depreciation. As one knows, the exchange rate reform is one of the key factors that help opening the Chinese capital account and in turn speeding up the RMB internationalization process. With the previous non-market oriented determination of the RMB exchange rate and the restricted floating ranges of RMB exchange rate, the rate failed to truly reflect the market demand and supply. The continued passive appreciation of RMB against USD and other currencies has been a huge burden for Chinese economy, therefore by doing so; it will greatly increase the flexibility of RMB exchange rate. Statistically, since the first RMB exchange rate reform in 2005 until August 2015, the RMB had appreciated 29.3% against USD, 47.98% against the euro, and 49.26% against the Japanese yen. This new mechanism reduces administrative interference of the exchange rate, increases exchange rate flexibility, and helps eliminating the “two-tiered system” (the exchange rate between onshore and offshore markets are different).