Changes in leadership since 1992 and deviations from earlier market reforms
Chinas economic performance was subject to intermittent reversals along with the changeover in the respective leadership - with Jiang Zemin, Hu Jintao and Xi Jinping, respectively taking over as presidents in 1992, 2002 and 2013. The Deng — era reforms to initiate the market were somehow modified with President Jiang Zemins public announcement that ‘China is a socialist market economy’ — implying a deviation from the goals of communism. The package of reforms and some of the regulatory measures introduced since then clearly deviated from its earlier pattern, especially relating to the management of the exchange rate and the stock market.
Changes in exchange rate management
Tracing the exchange rate management in China, one can identify at least four major breaks, which can also be held responsible for generating instability by instilling uncertainty in China’s financial market. Disruptions in the erstwhile stable financial market of China started in 2005 when the fixed official parity' of the RMB at 8.27 to US dollar in March 2005 was replaced by a floating rate which immediately pushed up the RMB rate to 8.11 per dollar by July 2005.1 While conceding to some extent, to the US lobby which accused China of‘cur- rency manipulation’ by keeping the RMB undervalued, the change generated expectations of further changes in the market, especially of an appreciation of the RMB against dollar.The next break in China’s currency management came in August 2007 when foreign currency was allowed, for the first time, to be privately held. Ending the mandatory sale of foreign exchange, the step enabled domestic companies and households to hold foreign currency as they wanted. Thus dollars, if desired, could flow out from private channels and cause deficits in the capital account, which happened later.
By that time, faced by an expected depreciation of the RMB, domestic importers did tend to advance payments in dollars, which affected the foreign exchange settlement between importers and banks. In addition, domestic exporters were inclined to hold on to export earnings in dollar rather than convert them to RMBs, which similarly affected the magnitude of foreign exchange settlement between exporters and banks. As a result, there emerged a tendency to short RMB and hold dollar long especially by 2011 when a possible depreciation of the RMB was officially recognised. By September 2011, an official announcement permitted a ‘two-way float’ of RMB a measure accepting, for the first time, possible depreciation of the currency, thus ending a long-standing consensus on the one-way RMB appreciation which prevailed until then. Changes which pushed the move included a moderate drop in the trade surplus and in the financial account balance of China.
Conditioned by the above changes, uncertain movements in the exchange rate, especially the expectations of a depreciation of the RMB, encouraged corporates as well as other private agencies including traders to hold on to dollar. Simultaneously external liabilities of the country started moving up with rising net inflows of portfolio capital from abroad. Policy shifts as above can also be held responsible for a decline in the official reserves between 2011 and 2012. As can be mentioned, the drop was caused by a jump in short-term trade credits to prepay (for imports) in dollar, a rise in dollar advances from banks and also withdrawal of dollar deposits from banks, much due to the expectations of further declines along with volatility in the RMB rate to US dollar.The exchange rate of the RMB, however, continued to waver with moderate appreciation between 2010 and 2014 and followed by bouts of depreciation between 2014 to 2016 and 2018 to 2019 (Jianxin and Sweeney, 2012).
Currency management in China was subject to one more change in April 2012 when the daily trading limit of RMB against dollar was officially widened from 0.5% to 1%. The move, allowing the rate to move in either direction, was designed, as held by Chinese experts, to encourage use of the currency in international markets. Moves as above, while liberalising the transactions, came with tendencies for speculation in the economy, especially on the RMB rate which had been subject to depreciation as well as a currency crisis during 2013 to 2015.
It is often argued that China, by holding a large stock of US Treasury Bills, got trapped in the uncertainty around the dollar-RMB exchange rate. China s RMB, while short of attaining the status of a convertible currency, has of late been in the limelight with its potential to be an internationally acceptable convertible currency (Bloomberg 2018).The currency is already in use to meet a considerable part of China s trade, especially with the neighbouring countries, while using swap arrangements to cover international payments. The PBoC took a lead in initiating swap arrangements, which preceded the inclusion of the currency in the SDR basket at the IMF2 (IMF News, 2016).The practice got reflected in the rising share of RMB in the official reserves held by different countries.
However, despite the disturbances in the financial market, exchange rate of the RMB was subject to the on-going management by the state. One can mention here the very unique relation between the state and the market in China with the former continuing to retain its prerogatives in the de-regulated markets, especially relating to finance. We find a reflection of above in China’s stock markets a discussion of which follows.
Relaxations of restrictions also introduced a pattern of instability in China s stock markets which witnessed a crash in June and July of 2015, preceded by a unforeseen boom therein which came along with a fast pace of liberalisation in the financial sector (Sen, 2015).