Risk, Regulation and Policy
Chapter 11: Renminbi’s ongoing exchange rate reform
Given the fact that Chinese currency, renminbi or yuan, is not freely convertible in the international foreign exchange market, foreign exchange is still heavily controlled in China even though major reforms swept the Chinese foreign exchange control regime in 2005. Whilst the foreign exchange liberalization reform has been underway, uncertainties exist and the market has to have a second guess at how further reform moves forward and whether the government will have a policy U-turn at a certain point. These uncertainties increase transaction costs and hinder China’s deeper financial reform. China’s foreign exchange policies after its economic opening in 1979 can be roughly divided into three phases. From 1979 to 1994, there were exchange controls on both current and capital transactions, and on both exports and imports as a result of which any economic transactions with foreign partners had to be conducted through state-owned trading companies. There was a two-tiered exchange system, that is, the official and swap markets. Until 1994, China had two official foreign exchange systems with different rates: an unfavourable one for foreigners and a better one for qualified Chinese enterprises. This created a thriving black market along with the formal market. The 1994 reform unified the two official foreign exchange systems by establishing an interbank foreign exchange system, which signalled China’s efforts to bring local practice into line with international standards. In this uniform system, the rate is set for foreigners at roughly the same level used internally by Chinese enterprises on swap markets.
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