China’s Foreign Exchange Market

• Presentation Outline

• Historical development of FX system

• Current FX system

Foreign Exchange Quotes

Financial Times or WSJ

• 1US$= 8.27 Yuan (or RMB)

RMB 8.27/US$– Indirect quote

• US$ 0.1209/RMB (=1/8.27)– Direct quote

1949-1978 Period

• China’s currency is called Renminbi, which is Not convertible

• Countertrade

• People’s Bank of China (PBOC) trades with Western Countries

• Low FDI (less than $300 million)

1978-1993 Period

• Deng Xiaoping initiated open-door policy in 1978

• New influx of trade

• FDI increased due to Special Economic Zones

• Difficulty of converting RMB into other currencies

1980 Onward• Dual Currency system

• Foreign Exchange Certificates (FECs) are issued for foreigners

• All FX under control of State Administration of Exchange Control (SAEC), a division of Bank of China

• Objectives– Curb FX speculation– Prevent foreign goods into China– Increase PRC FX reserves

Problems of FX System

• Swap Market System

• submit bids to government, which matches buy/sell orders

• Invertibility of RMB

• American motors corporation joint venture in Peijing halted production for lack of FX in 1986

• Currency value differs--black market

FX problems- continued

• Capital Flight

• Large PRC companies invest abroad and set up private accounts

• Overvalued official rate

• Swap rates were below the official rate

• Black market blooms

1994, New FX Reforms

• January 1, 1994, the official rate of RMB devalued by 33%

• Eliminate FX certificate practices

• Set up a new interbank trading system

Interbank System in China

• April 1994, a new interbank system called China Foreign Exchange Trading System (CFETS) was set up in Shanghai

• Linked to 24 cities across China via satellite and ground communications

• Trading rooms with orange-jacket dealers

• Daily trading turnover of US$270 million

FX trading practices in China

• Opening quotes are set by Bank of China on the basis of the rate on previous day

• RMB/US$ band is 0.3%

• RMB/HK$ band is 1.5%

• RMB/Yen band is 2-10%

• If quotes exceeds the band, trading stops automatically!

Trading (continued)• Execution

• 5-10 minutes wait for the response, if the order is rejected, try again

• if the sell price is low enough, bank of China is guaranteed to buy

• half of the seats in the interbank market are banks (Chinese and foreign)

• Strong reserves --US$154.67 billion (Dec 1999) - reduced pressure for devaluation