Now China is more willing than never before to carry out such a reform for various reasons. The 11 August depreciation is an important landmark in China’s long-overdue reform of its exchange rate regime. However, I guess, due to the fact that the RMB depreciation pressure is too strong, if the PBOC let the market makers to determine the central parity rate without intervention, the original planned one-off adjustment of the RMB exchange rate could morph into a rout, which is not a prospect the PBOC is ready to face. As a result, after testing the water just for two days, the PBOC retreated and told the market that the devaluation was just three percent and no more. Because the PBOC has enough ammunition to stabilize the exchange rate and the market also believes so, the exchange rate rebounded duly and calm returned to the market.
The 11 August episode has ended. However, the dramatic fall in the RMB exchange rate from 11 August to 13 August shows that the period of one-way appreciation of the RMB has ended. In the future, because of China’s capital account liberalization and RMB internationalization, the RMB exchange rate will become more volatile. It is very likely that because growth of the Chinese economy will continue to be weak, the PBOC will have to loosen monetary policy further. At the same time, the Fed will exit QE gradually. As a result, in the foreseeable future, the RMB is more likely to depreciate than to appreciate.
For the Chinese monetary authorities, how to allow the market to determine the RMB exchange rate while preventing the depreciation from sparking a rout is a serious challenge. For the rest of world, how to cheer China on to let go the RMB exchange rate while watching RMB depreciation in a quite manner is an equally serious challenge. Hopefully, neither side will fail the tests.
The author is former President of the China Society of World Economics and Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, and has also served on the Monetary Policy Committee of the People’s Bank of China.
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