Monday, June 21, 2010

The People's Bank of China Announces Increased Currency Flexibility

People's Bank of China: Further Reform the RMB Exchange Rate Regime and Enhance the RMB Exchange Rate Flexibility
Financial Times: China Vows Increased Currency Flexibility
Financial Times: New Renminbi Looks Like Deft Political Move
Financial Times: Renminbi Unchanged Despite Policy Shift
Wall. St. J.: China Says it Will increase Yuan’s flexibility
Wall. St. J.: PBOC: No One-off Adjustment of Yuan

A week before the G20 Summit, a conference that many believed would be a “showdown over the level of the Chinese currency,” and amid increasing worldwide criticism over its tightly controlled exchange-rate regime, China announced that it will introduce more flexibility into its exchange-rate. Over the past 20 months, due to the financial crisis, China adopted a fixed exchange-rate policy, that effectively pegged the foreign exchange rate at 6.83 yuan per dollar. However, on June 19, the People’s Bank of China (PBOC) announced that it will make the yuan’s exchange rate more flexible without providing details of the exact size, timing, or shape of a possible revaluation.

Even though the details of the change are unknown, some commentators have praised China’s move. Some have even gone as far as saying that the move marks “the beginning of a new era.” These individuals believe that the new policy will “make a positive contribution to strong and balanced global growth” and increase competitiveness in international trade. Additionally, the change could benefit China's economy by increasing Chinese household income. These beliefs are valid if there is significant appreciation. However, other commentators believe that the announcement is a political ploy and that rapid appreciation of the yuan is unlikely.

Commentators have rightly characterized China’s move as a “canny” and “deft political move” for numerous reasons. First, the announcement by the PBOC came one week before the G20 Summit where many expected the focus to be on China, its undervalued currency, and its large current account surplus. Second, there is no concrete plan of action for implementation of the change. Third, and most significantly, in a follow-up statement one day after China announced that it would introduce more flexibility, China stressed that substantial appreciation in its currency was not in its best interest and that the exchange rate would remain “basically stable.”

Thus, the announcement that China is introducing flexibility into its exchange rate likely had only one effect: shifting the focus off of China at the upcoming G20 summit in Canada.

1) Is there any indication that this was more than a well-timed political move?
2) If China did succeed in shifting the focus of the G20 summit off of its currency, what do you believe will be the new "hot topic" of discussion?

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