Why was China defending its currency from a BOP (+) position in 1997-2005 and fr
ID: 1214121 • Letter: W
Question
Why was China defending its currency from a BOP (+) position in 1997-2005 and from a BOP (-) position in 2015? (Be sure to include a description of China's exchange rate policy and development strategy in the two different eras and why China changed these policies. What has been the role of the IMF in this policy change?) (b) The Wall Street Journal reported that the number of labor strikes in China in 2015 was double the number from 2014. Explain how and why this is related to your answer in part (a). (c) Since 2015, what has the PBoC (China's central bank) had to do to stop RMB depredation? Explain the likely effects of the PBoC's defense of the RMB on the Chinese economy with and without sterilization.Explanation / Answer
Ans- (a)China's challenge to international monetary order is at least as serious.The Chinese economy experienced astonishing growth in the last few decades that catapulted the country to become the world's second largest economy. In 1978—when China started the program of economic reforms—the country ranked ninth in nominal gross domestic product (GDP) with USD 214 billion; 35 years later it jumped up to second place with a nominal GDP of USD 9.2 trillion.
Since the introduction of the economic reforms in 1978, China has become the world’s manufacturing hub, where the secondary sector (comprising industry and construction) represented the largest share of GDP. However, in recent years, China’s modernization propelled the tertiary sector and, in 2013, it became the largest category of GDP with a share of 46.1%, while the secondary sector still accounted for a sizeable 45.0% of the country’s total output. Meanwhile, the primary sector’s weight in GDP has shrunk dramatically since the country opened to the world.
China’s Balance of payments
China’s external position is extremely solid. The current account has recorded a surplus in every year since 1994. The capital account followed suit and only recorded two deficits in the last 20 years. This situation of surpluses in the both the current and the capital put pressure on the national currency and prompted the Central Bank to sterilize most of the foreign currency that entered the country. As a result, China’s foreign exchange reserves skyrocketed to almost USD 4.0 trillion in 2014. The current account surplus reached its peak in 2007, when it represented 10.1% of GDP. Since then, however, the surplus has narrowed and in 2013 it fell to only 2.0% of GDP.
China’s capital account has bold controls, which implies that the country lacks the freedom to convert local financial assets into foreign financial assets at a market-determined exchange rate and vice versa. The new Xi-Li administration and the People’s Bank of China vowed to accelerate interest rate liberalization and capital account convertibility. In this regard, Chinese authorities have started to implement some measures, such as removing a cap on foreign-currency deposit rates in Shanghai.
The capital account benefited from strong inflows of Foreign Direct Investment (FDI). FDI has performed strongly in the last decade, with record inflows of USD 118 billion in 2013, thereby becoming the second largest recipient of foreign investment. Among the countries that invest more in China are Hong Kong, Singapore, Japan, Taiwan, and the United States. In addition, China’s outward investment soared in recent years and, according to some analysts, the country could become a net exporter of capital in the coming years.
Cina has rejected to adopt flexible exchange rate policy which would promote the adjustment of it's BOP position and help to avoid a build up of large imbalances.As noted earlier it has infct intervened massively in the currency market to maintain substantialy undervalued exchange rate,which has produces huge trade and current account surpluses that are by far the largest counterparty of Usand current acount deficit.This imbalances and unprecendent flow of international fund that they require could trigger at almost any time a crash of dollar and hard landing of global economy,severely compounding the current financial crisis.
Todate however China has registered the pleas of United State and other to confirm to international monetary norms.It announced move to a managed floating exchange rate based on market supply and demand in july 2005 has still produced only a modest rise in the trade weighted rate of it's currency,despite the recent acceleration of it's bilateral appreciation against the dollar and a small moderation at best in the continued huge surpluses in its external accounts.It's intervention in the currency market to block faster appreciation has infact at least doubled since that time implying a policy that is less rather than more market oriented.
Hennce China's behaviour poses a fundamental challenge to the operation of the global monetary regime and to the effectiveness of it's institutional guardians,IMF.Far from accepting IMF advise it has strenuosly objected even to the principal of farm involvement in the issue.Underlying this debate is the implicit threat that China might promote creation of an Asian Monetary Fund-which provides the fulcrum for Asian Monetary Corporatind-and further erode global role of IMF.
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