The Renminbi Exchange Rate

inSight

06 Jul 2000

The Renminbi Exchange Rate

Concerns about a negative impact on the Hong Kong dollar of any change in the renminbi exchange rate system seem to be unnecessary in the light of the clear de-coupling in the movements of the two currencies since late 1998.

Recently, attention has been drawn once again to the possible impact on the Hong Kong dollar of any change in the renminbi exchange rate system. I read from the newspapers that the initial reaction of some to discussion of a possible change was one of rather serious concern. This is understandable in view of the perception, which is somewhat entrenched in sections of the community, that, rightly or wrongly, the interdependence of the economies of the Mainland and Hong Kong is such that there would be a strong mutual influence between the exchange rates of the two currencies.

But the fact of the matter is that the Mainland and Hong Kong are two different economies, with distinctly different characteristics, pursuing different exchange rate policies for two different currencies. Without wishing to stimulate another round of emotive rebuttals from the minority few who dogmatically favour floating exchange rates, let me point out further that Hong Kong pursues a fixed exchange rate policy that is realistically supported by other prudent macroeconomic policies. Moreover, the mechanism for maintaining that fixed exchange rate - through currency board arrangements - is most robust. Under the circumstances, and assuming that the high credibility that Hong Kong's exchange rate system commands is sustained, there is no reason why the fixed exchange rate of the Hong Kong dollar should be unduly affected by the movements, if any, of the renminbi exchange rate.

Indeed, this seems to have been the market sentiment for some time now. As pointed out before in this column, since the fourth quarter of 1998, after the introduction of the seven technical measures to strengthen our exchange rate system, there has been a clear de-coupling in the market expectation of future movements of the exchange rates of the two currencies. There is now no correlation between the forward premium for the renminbi and that for the Hong Kong dollar. Consistent with this approach, the market also reacted very calmly to the issue surfacing again at this time. The Hong Kong dollar exchange rate and Hong Kong dollar interest rates hardly moved.

Turning to the exchange rate policy of the renminbi itself, it is my understanding that a managed float has been in practice for some time and that there is no intention to depart from this in the immediate future. Indeed, the renminbi has been trading within a very narrow band in the past couple of years. The most relevant question is whether there is a case to have the band widened in order to give greater flexibility to the movement of the exchange rate. With fairly tight exchange controls in the capital account and a relatively small external sector, there is obviously some safe scope for the use of the exchange rate as a tool for macroeconomic management.

But, with exchange controls, we need to be aware of the fact the People's Bank of China (PBoC) is the ultimate "banker" to renminbi foreign exchange transactions. Any such movement in the exchange rate therefore is a reflection of action on the part of the PBoC, involving the discretionary decision to allow the exchange rate to move in a particular direction. Of course, the discretionary decision can be made on the basis of the supply and demand of foreign exchange, respectively put to and requested from the State Administration of Foreign Exchange largely by exporters and importers. But discretion is no doubt involved and we should therefore use the term "free float", whether within a defined band, with this important qualification in mind.

Moreover, in considering such matters, a distinction should be made between two different concepts, namely, the convertibility of a currency and the exchange rate system for that currency. To allow the exchange rate of a currency to "float freely" is quite different from allowing a currency to be "freely convertible", although, as I pointed out earlier, a currency that is not freely convertible cannot, strictly speaking, be freely floating. In so far as the renminbi is concerned, my guess is that the recent attention focuses on the pros and cons of greater flexibility for the renminbi exchange rate within wider bands, and not convertibility. The latter is a much more complex and risky issue best for consideration, I would suggest - to borrow a bureaucratic term - in the fullness of time.

Joseph Yam
6 July 2000

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Last revision date : 06 July 2000