YI Gang, vice-governor of the People's Bank of China and CPPCC member, talked about issues concerning the RMB exchange rate and the development trends of China's economy on the sidelines of the two sessions on March 6, 2016.

Continued RMB Depreciation?

The RMB has depreciated almost five percent over the one month since the launch last August of marketization reforms of the RMB exchange rate. Will the RMB exchange rate continue to depreciate? Yi said in answer to this question that the RMB will achieve fundamental stability at an appropriate level, and that there is no basis for continuous depreciation.

First of all, the Chinese economy maintains medium-to-high growth, and its labor productivity is steadily improving. Second, China's current account surpluses are massive, and both foreign direct investment and outbound direct investment are increasing. Third, the country has ample foreign exchange reserves. From a long-term perspective, therefore, the RMB exchange rate will remain stable.

Perfect the Interest Rate Adjustment and Transmission Mechanism

Yi holds that advancing the market level of China's interest rate entails prioritizing enhancement of effective central bank regulation of the market interest rate, while perfecting the interest rate transmission mechanism. When elaborating on the carrying out of such institutional mechanism reform, Yi focused on three points.

First, the central bank should improve its policy rating system and so better guide the interest rate market level. It can accomplish this by setting up an "interest rate corridor" mechanism through which to introduce deposit and lending facilities to commercial banks. The central bank determines the difference between the rates of deposit interest and loan interest, so as to better regulate and guide the interest rate. Second, the central bank will achieve the transition from controlling short-term interest rates to controlling long-term interest rates. This requires a more mature market and financial organs that have pricing ability. In addition, the re-lending rate, medium-term lending facility and the like are expected to help in the shaping of medium-and long-term interest rates. Third, the market interest rate risk pricing mechanism must be perfected. Last but not least, pricing of the interest rate should be constrained through macro-prudential assessment, and emphasis given to the quantity and price coordinating mechanism.

Private Sector Root of Foreign Reserve Reduction

China's foreign reserves fell from a peak of US $3.99 trillion in 2014 to US $3.3 trillion by the end of 2015, so polarizing world attention. Yi explained the reasons for the drop in central bank foreign exchange reserves.

He holds that there could be extra capital inflows, as China's foreign exchange reserves have increased over the past decade. It will hence be no surprise if such capital flows out of China at some point. He further argued that foreign exchange reserves have gone to the private sector. In other words, foreign exchange reserves held by the central bank have been bought by the public. In the past year or so, Chinese enterprises and households have been optimizing their balance sheets by adding to them assets in the form of US dollars. Banks and other financial institutions have also increased the amounts of foreign exchange on their balance sheets. At the same time, enterprises have made predominant use of foreign currencies to pay certain debts. All of these examples entailed buying foreign exchange on the market, so leading to a drop in the central bank's foreign exchange reserves. Yi observed that in 2015, both Chinese corporate and individual outbound payments in foreign currencies surpassed inbound payments by US $240 billion. This amount included foreign direct investment, portfolio investment, tourism, and education, to name a few examples. He also stressed that US dollar appreciation is partly the reason for the drop in foreign exchange reserves.

In Yi's opinion, foreign exchange reserves will be maintained at a proper level, because there are limits to corporate and individual balance sheet adjustments. Consequently the level of foreign exchange reserves will return to normal in a due time. On top of that, Yi observed that China manages its foreign exchange reserves based on fluidity, safety, and profitability. In addition to US dollars, China's foreign exchange reserves also consist of Euros, Japanese yen, pounds sterling, and the assets of developing countries.

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