Why does China still have a ‘pegged’ currency, like those of Iran, Laos, Belarus?

Time is ripe for world’s second-largest economy to cut the ties that bind yuan to the US dollar, expert says

PUBLISHED : Tuesday, 05 September, 2017, 4:34pm
UPDATED : Tuesday, 05 September, 2017, 10:36pm

China should finally free its currency from the US dollar peg to which it has been tied for more than 30 years, a leading Chinese economist said.

As the world’s second-largest economy, it was no longer appropriate for the country to have an exchange rate system akin to those used by Iran, Belarus, Ethiopia, Uzbekistan or Laos, Yu Yongding, was quoted as saying in an interview published on Monday by China Securities Journal.

The long time advocate for a market-based exchange rate system – he was an adviser to the People’s Bank of China when in 2005 it first announced plans to free the yuan from the dollar – said it was time for the current “soft pegging” system to be discontinued.

“The time to turn to a free float [yuan] exchange rate is basically ripe after more than 20 years of trials,” the senior research fellow at the Chinese Academy of Social Sciences said.

Time right to loosen controls on yuan-dollar exchange rate, says China state-run paper

The present economic conditions – stable economic growth, reduced capital outflows and lower expectations of a yuan depreciation – were ideal for Beijing to complete “the historic mission” and let the market, not the central bank, finally decide the currency’s value.

China’s exchange rate system can be traced back to 1994, when Beijing unified several existing values and “pegged” its currency at 8.70 yuan to the US dollar.

In 2005, the government said it wanted to liberalise the currency and promptly devalued the currency by 2 per cent. Despite that first move, China has never fully succeeded in removing its ties to the US dollar.

The government continues to maintain strict controls on the yuan’s movement – allowing it to appreciate or depreciate just 2 per cent from a “midpoint price” set daily by the central bank. Earlier this year, the People’s Bank of China adopted a “counter cyclical factor”, which gives it – rather than the market – even greater ability to control the currency’s value.

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In August 2015, Beijing again devalued the yuan by 2 per cent in a move originally aimed to better align the exchange rate with the market. However, the move, which came amid a stock market rout, amplified fears about China’s economy and caused an exodus of funds, Yu said.

“It was an important attempt towards a floating system, and the direction was correct,” he said.

“In hindsight, had China chosen a better time or ... insisted on liberalisation amid heightened yuan depreciation expectations ... [it] would have basically completed its exchange rate reform by now.”

Beijing’s heavy handed control of the yuan has made it a target for criticism among its trading partners.

US President Donald Trump has accused Beijing of manipulating the value of its currency to gain trade advantages, though the US Treasury has yet to formally label China a currency manipulator.

The International Monetary Fund, which awarded nominal reserve currency status to the yuan last year, has also pressed China to continue with its yuan liberalisation.

Beijing says yuan policy is actually doing US a favour

China’s central bank has said repeatedly it was moving towards a “managed floating yuan exchange rate system” and was engineering a gradual appreciation of the yuan against the dollar. On Tuesday, it raised the official yuan midpoint for the seventh straight session, to 6.537 per dollar, the strongest level since May 18, 2016.

But that is not enough for Yu. As the world’s largest commodity trader and holder of the world’s biggest foreign exchange reserves, it was no longer right for China to allow its currency to be linked to the US dollar, he said.

It was time for the “relevant authorities” to seize the opportunity and set it free, he said.