It was at the 3rd Plenary Session of 14th CPC Central Committee that the goal of establishing a managed floating exchange rate regime based on market supply and demand was outlined. In January 1994, with the unification of RMB’s (renminbi) official exchange rate and swap rate, the single, managed floating exchange rate based on market supply and demand was officially adopted.

The RMB exchange rate gradually approached an adaptive level, which helped enhance the competitiveness of export-oriented enterprises and facilitated the shift from trade deficit to surplus.

During the Asian financial crisis in 1997, the RMB exchange rate was kept stable around 8.3 yuan to one dollar in order to brake competitive devaluation of Asian currencies. Though the impacts of Asian financial crisis subsided in 2001, the RMB was kept at a stable level against the US dollar as unfavorable factors, such as deflation, arose domestically.

Reflecting on the crisis, China stepped up the financial reform and infrastructure building. Researches and preparation on resuming exchange rate floating were also well under way. As financial institutions had not completed reform and were not yet prepared to handle exchange rate movements or provide enterprises with relevant services, the reform of large-sized state-owned commercial banks was conducted before exchange rate reform.

The reform in large financial institutions, which is the basis for exchange rate regime reform, was completed by July 2005. The Bank of Communications, China Construction Bank and the Bank of China finished financial restructuring and became listed companies. The financial restructuring of Industrial and Commercial Bank of China was put on agenda and the preparation for the reform of China Development Bank and the Agricultural Bank of China was under way. In addition, China’s accession to the WTO had significantly enhanced the competitiveness of export-oriented enterprises. With continued expansion of trade surplus, Chinese enterprises and financial institutions were better prepared for the reform of the RMB exchange rate regime. With these conditions in place, the reform of exchange rate regime was launched decisively.

Around end July 2008, in order to address the deepening international financial crisis, China narrowed the floating range of RMB exchange rate and did not devalue the currency as many other countries did. This contributed much to stabilizing external demand, helped mitigate the impacts of the international financial crisis, and promote Asian and global economic recovery. Global economy is now recovering and China’s economic recovery and upturn is more entrenched.

In this context, as approved by the State Council, the PBC decided to further the reform of exchange rate regime and enhance the flexibility of RMB exchange rate on June 19, 2010. New challenges may arise as international economic and financial situations evolve, but the reform of RMB exchange rate regime will continue in line with our established policy.

China has moved into a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies. This is a right choice based on China’s specific circumstances and development strategy. As an important component of the socialist market system and in line with the scientific approach to development, the exchange rate regime is needed in the country’s endeavor to deepen reform and adapt to the new situation after China’s accession to the WTO.

In line with China’s long-term and fundamental interests, a managed floating exchange rate regime is an inevitable choice that will facilitate economic restructuring and comprehensive, balanced and sustainable development, help strengthen macroeconomic management and facilitate China’s economic development at the juncture of strategic importance.

The goal of China’s economic policies is economic growth, full employment, price stability and a balanced BOP account. A package of restructuring measures is needed to address structural problems of high savings rate and inadequate domestic demand. In this package, exchange rate policy plays a role no less important than general industrial policies as it has an impact on domestic and foreign relative price in an aggregate sense. A misaligned domestic and foreign relative price leads to the distortion of domestic prices and undermines the stable, balanced and sustainable development of the economy.

Core competitiveness of the corporate sector has been strengthened as a result of heightened efforts to upgrade and innovate products. This facilitated the optimization of export structure and the shift of trade and growth pattern. From 2006 to 2008, the structure of China’s exports further improved.

Meanwhile, the process of “Attracting Foreign Investment, Technology and Management Expertise” and “Going Global” gained momentum, enabling China to play a bigger part in global industrial chain and the international market. Being more responsive to exchange rate movements, large amount of export-oriented enterprises conducted proactive financial management and raised selling prices to cover exchange rate losses. Improved in quality, China’s foreign trade registered further development.

Domestic demand supported by import expansion and lower import cost helped ease inflationary pressures. From June 2005 to June 2008, China’s import volume totaled $2.729 trillion. A total of 1.6497 trillion yuan of import cost was saved as a result of RMB appreciation against the dollar.

Resource allocation was optimized, promoting economic restructuring and more balanced development. As a result of macroeconomic policies including exchange rate policy, the industrial structure became more balanced with the service industry contributing 42.9 percent to GDP growth in 2008, a growth of 2.6 percentage points from 2005.

The geographical distribution of industries improved as the labor-intensive industry accelerated its reallocation to the central and western part of China, facilitating the implementation of national development strategy. In 2008, share of central and western region in China’s GDP was 37.1 percent, up 1.3 percentage points from 2005. As more resources have been channeled to economic sectors driven by domestic demand, domestic demand contributed 90.8 percent to economic growth in 2008, up 14.9 percentage points from 2005. The concentration of labor force in the export sector as a result of an undervalued exchange rate has been partly corrected as more jobs have been diverted to the services industry, which is largely nontradable. According to the National Bureau of Statistics (NBS), the number of people employed in the services industry as a percentage of total employment increased by 1.8 percentage points between 2005 and 2008.

The reform of exchange rate regime has demonstrated to the international community China’s commitment to promote global economic balance, providing a more facilitating international environment. A floating RMB exchange rate shows that China is dedicated to promote global economic balance and that China is a responsible member in the international community.

The potential adverse impact of the RMB exchange rate reform in 2005 was effectively managed thanks to the principle of making the reform a self-initiated, controllable and gradual process. The corporate sector became increasingly resilient to the reform, which was reflected in improving import and export indicators amid a host of shocks, including a stronger RMB, lower export rebate rate and rising labor cost. Export was not substantially affected.

From 2006 to 2008, the golden period for China’s foreign trade, export grew by 23.4 percent annually, and import by 19.7 percent. Exchange rate floating helped upgrade the export model from simple processing to deep and intensive processing, extended the production chain, and improved division of labor, ultimately contributing to higher employment. According to the NBS, total employment increased by 16.55 million during the period from 2006 to 2008.

In fact, most Chinese companies have developed the ability and mechanism to adjust to changes in the market after nearly three decades of market-oriented reform, which warrants the application of dynamic analysis.

In an ever-changing market environment, the corporate sector manages market and other risks including exchange rate risks in a dynamic manner. Operating in a market economy, an enterprise has to face many changing parameters, including raw material prices, wage, export tax rebate, market demand, distribution channel, product mix and cycle, public utility price, and etc. The annual movement of any of these factors is often more than then 10 percent. As one of these variables, the exchange rate usually does not experience large swings.

In a market economy, it is no longer feasible to adopt the planned economy measures to fix the external factors for enterprises. In a globalized environment, enterprises have fewer and fewer risk free long-terms orders and have to accept orders with shorter maturities. Enterprises around the world are adapting to the changing market conditions, including the changes in demand, distribution channel and price of input and output, exchange rate, hedge price, insurance price, and etc, and are managing the risks through information technology (such as low or zero inventory, shorter production cycle and outsourcing) and financial instruments.

In summary, the RMB exchange rate regime reform has been advanced smoothly in a self-initiated, gradual and controllable process since 2005. The reform plays a positive role in supporting the real economy, and creates favorable conditions for meeting macroeconomic management objectives. It helps promote a balanced BOP account, expand domestic demand and restructure the economy, and has been important in China’s efforts to address various domestic and global developments.

— Hu Xiaolian is the Deputy Governor of the People’s Bank of China