Academic journal article China: An International Journal

The Institutional and Structural Problems of China's Foreign Exchange Market and Implications for the New Exchange Rate Regime

Academic journal article China: An International Journal

The Institutional and Structural Problems of China's Foreign Exchange Market and Implications for the New Exchange Rate Regime

Article excerpt

After briefly reviewing the historical development of China's foreign exchange market, this article examines the structural characteristics of the inter-bank market, describes its current structural problems as well as its institutional constraints and explores the delicate relationship between improving the foreign exchange market structure and reforming the RMB exchange rate regime. The inter-bank market is characterised by lack of market depth, limited transaction types and restricted participation with highly concentrated trading. The compulsory foreign exchange purchase and sales system distorts market supply and demand while the rigid exchange rate regime reduces the role of the Central Bank to one of passive intervention.

Two months after China's foreign exchange market added eight foreign exchange pairs to its inter-bank trading family, the People's Bank of China (the Central Bank) announced a reform of the RMB exchange rate regime featuring a two per cent appreciation of the RMB against the US dollar and a basket peg. (1) The regulators' intention to divert attention away from speculation on the exchange rate level and focus on improving the exchange rate formation mechanism seems to have resulted in many moves to overhaul China's foreign exchange market. The relationship between market structural improvement and reform of the exchange rate regime has become increasingly important to China as it works towards a more flexible exchange rate regime.

A substantial body of literature has taken shape on China's foreign exchange (FX) market itself, (2) or in connection with issues such as the convertibility of the RMB and the liberalisation of current and capital accounts. (3) However, in-depth analyses of the foreign exchange market's structural characteristics are rare. Chen Haiwei estimates China's foreign exchange market concentration and attributes the high concentration to FX control measures, limited convertibility of RMB, market entry restrictions and historical institutional arrangements. (4) He characterises the FX market structure as a closed monopoly. In recent years, some descriptive analyses of market structures have been noted in the literature. Ma et al. compare China's FX market with major world markets and find the Chinese market to be small, segmented and concentrated in US dollar trading with a nascent forwards market but missing a swap market. (5)

Wang Xin identifies several structural problems such as the small trading volume, high market concentration, poor liquidity, limited transaction instruments and significant settlement risk. (6) He traces the problems to a "super stable" RMB/US dollar exchange rate and points out that in China, for increased flexibility of the exchange rate, the FX market must expand considerably from its current depth and scope. While observers outside China have complained about the misalignment of the RMB exchange rate level and have called for a more radical approach to achieving exchange rate flexibility, domestic scholars and policy makers have preferred to exercise caution. Zhang Jikang argues that China's FX market should be developed gradually, controllably and optimally under the premise of stability. (7) Ba Shusong suggests a reform of the FX market with respect to its operations, transaction platform, competition rules, market entities and targeted functions. (8) This paper goes further than previous work by relying on quantitative data, for the ten years since the current exchange rate system was established in 1994, to systematically analyse the structure of China's FX market and assess its performance. (9) The basic premises are these:

* China's FX market has developed under an institutional framework involving a compulsory FX purchase and sales system, a de facto pegged exchange rate and inconvertible RMB under the capital account. (10) As these institutions cannot be changed quickly, the Chinese Government has moved gradually to reform the FX market at a pace more broadly commensurate with the economic reforms in general. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.