Experts question pace of change, need for intervention

Updated 2017-09-05 09:30:45 Global Times

As the yuan continues to rally against the U.S. dollar and is backed by signs of improved domestic fundamentals, a debate over whether the country's push for a more market-oriented rate-setting mechanism is moving ahead at the right pace is growing among prominent scholars.

Some experts suggest that, given the more solid fundamentals in the domestic economy, the People's Bank of China (PBOC) should be able to complete the reforms more quickly, while others argue that the reforms have already proven effective and should continue to be implemented in a gradual fashion to prevent major fluctuations.

Yu Yongding, a monetary policy expert at the Chinese Academy of Social Sciences, questioned the PBOC's decision to continue the use of the central parity system, which weighs the yuan's exchange rate against the previous closing level and a basket of currencies.

Yu, a former PBOC adviser, argued in an interview on Monday with the China Securities Journal that the mechanism is not based on market demand and supply but affected by the PBOC's interventions, so it is not in line with the PBOC's reform goal to have a market-oriented system and allow the currency to float freely.

"Frankly, I don't understand the central bank's logic anymore," Yu was quoted as saying. "Personally, I think the main problem with the 'closing price plus changes in the rates of a basket of currencies' pricing mechanism is that it can't accurately reflect market demand and supply and the yuan's exchange rate is still affected by the central bank's intervention."

The central parity system was put in place in August 2015 as part of the country's drive to let market forces have a larger say in the yuan's exchange rate and allow the yuan to float freely, amid a major push for the internationalization of the Chinese currency.

The move initially prompted a steep fall in the yuan's exchange rate against the U.S. dollar and, experts say, partially contributed to a wave of capital outflows from the world's second-largest economy.

But under a combination of measures from the Chinese government, including tight control of overseas investments by domestic firms and other monetary policy adjustments, the yuan has stabilized since the beginning of 2017 and continues to rally against the U.S. dollar.

After strengthening to a 14-month high against the greenback on Friday, the yuan continued to gain on Monday, rising 0.58 percent to 6.5185 per dollar at the close.

Yu argued that amid positive signs in economic growth, balance in international accounts and stable capital movements, the conditions are right for the PBOC to complete the market-oriented reforms for the pricing mechanism.

Reforms should be gradual

However, several other experts cautioned against any radical moves and argued that the reform is proceeding at the right pace, ensuring both progress and stability.

"It's very important that we understand one thing clearly: Market reforms don't mean we will suddenly let the yuan float completely freely. It has to take place gradually and ensure stability," Dong Dengxin, director of the Finance and Securities Institute at Wuhan University of Science and Technology, told the Global Times.

Dong said the exchange rate-setting mechanism in China is now "more market-oriented and transparent" than at any time in history. "We have to acknowledge that," he noted.

Cheng Shi, head of ICBC International Research Ltd, also said that since the reforms in August 2015, the yuan's exchange rate has returned to normal movements and the currency has achieved several milestones, including becoming part of the IMF's Special Drawing Rights basket of currencies.

"Since the reforms [in August 2015], the flexibility of the yuan's exchange rate has been significantly enhanced and financial opening has increased," Cheng told the Global Times on Monday.

Cheng said that the market reforms should be carried out gradually. Trading hours in the domestic foreign exchange market could be extended and more market participants could be brought in, in accordance with market conditions.

Experts on Monday also rejected criticism of a recent decision by the PBOC to add "countercyclical factors" to the formation of the central parity system. Critics said the move showed a desire to intervene in the setting of the exchange rate.

Dong disagreed. "This is a move that has been adopted in many countries around the world, including the U.S., to prevent irregular market movements; if anything, this shows China is becoming more forthcoming and transparent in its policy," Dong said.

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