Now that the global recovery has taken hold and with the Chinese economy gaining ground, China's central bank—the People's Bank of China—has decided to proceed with reform of the renminbi (yuan) exchange rate regime and improve the flexibility. The central bank's spokesman on June 20 addressed a number of concerns over the issue in a statement posted on its website. Edited excerpts follow:

General guidelines

Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. The managed floating exchange rate regime is a well established policy in China. We will be following these guidelines in the reform process this time.

Progress since 2005

The reform has been a success. Starting from 2005, the renminbi exchange rate regime reform—in a proactive, gradual and controllable process and as part of China's independent policy initiatives—has been progressing in an orderly manner. Overall, the reform has played a positive and supportive role in China's economic development through facilitating macroeconomic management in a changing domestic and international environment. It has produced a number of anticipated results. First, it has encouraged enterprises to adopt new technologies, promote innovations and enhance core competitiveness, and helped the export sector maintain overall competitiveness. Second, a floating exchange rate regime has helped improve the export structure and trade pattern, and driven China's economic growth to become more comprehensive, balanced and sustainable. Third, exporters now are more aware of the need to adapt to exchange rate floating, which has helped them to develop a stronger ability to adapt to exchange rate movements and manage risks, and in turn contributed to the foreign exchange market development. Fourth, the reform has demonstrated to the international community China's efforts to promote a balanced global economy.

Considerations behind China's exchange policy

As a result of the global financial crisis in 2008, the global economy, including the Chinese economy, faced multiple difficulties and uncertainties. China narrowed the floating range of renminbi exchange rate as a response to the crisis. The renminbi exchange rate remained basically stable in the worst of the crisis, while a number of other major sovereign currencies depreciated against the U.S. dollar. The policy helped China to uphold external demand and mitigate the shocks of the financial crisis. The renewed economic strength in China also contributed greatly to the Asian and global recovery. The experiences in the past two years have shown that it is the right choice.

Key aspects in continuing the reform

Based on the 2005 reform, the reform this time will not involve a one-off exchange rate revaluation. Market supply and demand will continue to play a fundamental role for exchange rate determination with reference to a basket of currencies. The renminbi exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market. The objective is to stabilize the renminbi exchange rate basically around an adaptive and equilibrium level, and in the meantime, to improve China's balance of payments (BOP) situation, and achieve economic and financial stability.

Benefit from further reform

The reform serves China's long-term and fundamental interests. First, a floating exchange rate is more responsive to changes of relative prices of domestic and external sectors, and thus helps draw resources to sectors such as the service industry driven by domestic demand. It promotes industry upgrading, improves the growth pattern, reduces trade imbalances and makes the growth less export-reliant. Second, it helps contain inflation and asset bubbles, and enables macroeconomic management to be more proactive, effective, and controllable. Third, it helps nurture strategic opportunities for China's development. Further reforming the exchange rate regime will provide a favorable environment for international trade and investment and more strategic opportunities for long-term cooperation between China and other countries for mutual benefits.

Avoiding negative impacts

First, it is important to avoid any sharp fluctuations in the exchange rate. As China's BOP is now moving closer to a more balanced position, prices of labor, raw materials, land and other capital goods have become higher, which raises the cost of China's export. The basis for a large-scale renminbi appreciation does not exist as the exchange rate is moving closer to its equilibrium level. Second, the orderly floating of renminbi exchange rate should reflect China's economic fundamentals and meet the needs of macroeconomic management. While a floating exchange rate will promote a more balanced BOP account in general, it does not address bilateral trade imbalances with any particular country. Third, the reform will be gradual, in line with how the corporate sector responds to changes in the exchange rate. The purpose is to maintain an orderly industrial upgrading, maintain the international competitiveness of Chinese enterprises and provide more jobs in the service sector. Fourth, supervision and regulation on short-term capital speculation would need to be strengthened to protect China's financial system from major external shocks.

Right timing

China's economic recovery has taken hold and the reform will facilitate the country's economic restructuring by improving the growth quality and efficiency. In addition, a two-way floating renminbi with greater flexibility will make macroeconomic management more proactive and effective, in response to various external shocks.