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Market's role in setting exchange rate

By Zheng Lifei (China Daily)
Updated: 2006-08-11 08:48

China will let market forces play a fundamental role in forming the exchange rate and gradually increase the flexibility of the yuan, the central bank said yesterday.

The People's Bank of China (PBOC), however, "will keep the reasonable and balanced level of exchange rate of the renminbi basically stable," it said in a statement issued yesterday to mark the one-year anniversary of last July's landmark foreign exchange reforms.

China abandoned its decades-old dollar peg and shifted to a managed float against a basket of currencies on July 21 last year, when it also revalued the yuan by 2.1 per cent.

The yuan has gained an accumulated 3.8 per cent since then.

The daily benchmark, or the central parity rate for the US dollar, was set at 7.9688 yesterday, according to the Shanghai-based China Foreign Exchange Trade System.

"The reform (to date) has achieved its desired results," the PBOC said in the statement, noting that it will press ahead with its foreign exchange regime reform and develop its foreign exchange market in an "active, controlled and gradual" approach.

The central bank said that it would let the forces of supply and demand in the market play an increasingly fundamental role in determining the exchange rate.

It also pledged yesterday to develop the country's fledging foreign exchange market by introducing more risk-hedging instruments and expanding the investment channel for both businesses and households.

Financial institutions, the PBOC said, "are encouraged, with a sound risk-control mechanism as the precondition, to actively conduct financial innovation."

The central bank also vowed yesterday to improve its foreign exchange management, further facilitating the freight and services trade.

How to manage the country's mounting foreign exchange reserves, already the world's largest, has long been a challenge for the central bank.

The ballooning trade surplus, which surged to a record high of US$14.61 billion last month, coupled with the inflow of foreign investment, had propelled the country's foreign exchange reserves to a record high of US$941.1 billion by the end of June.

The central bank is encouraging a policy shift from stockpiling forex reserves in State coffers to letting businesses and residents hold more foreign currency.

The PBOC has in recent months loosened foreign exchange restrictions on companies. It said yesterday that it would further relax the requirement for companies to sell foreign exchange to the central bank, but the bank did not elaborate on what specific measures it would take.

It also vowed to put in place a foreign exchange management regime in which domestic companies would be encouraged to "go abroad."

The PBOC said it would improve the monitoring and warning system on short-term cross-border capital flows to "ensure national financial security and stability."