China abolishes yuan-dollar peg, adopts floating rate

By Xu Binglan (China Daily)
Updated: 2005-07-21 19:37

In a long-awaited but unexpected move, China yesterday announced that its currency will no longer be pegged to the US dollar.

From now on the renminbi, or yuan's, exchange rate will be made in reference to a basket of currencies, the People's Bank of China (PBOC) said, adding that it marked the introduction of "a more flexible mechanism for the exchange rate's formation."

The central bank did not specify what currencies would be in the basket.

The central bank strengthened the exchange rate of the renminbi to 8.11 to the dollar, up from 8.28, where it had been fixed for years, it said in a surprise announcement on the State television evening news.

The change amounts to a 2 per cent appreciation of the renminbi.

The reform is "in the interests of the country's long-term, fundamental interests," the central bank said in a separate statement.

Pursuing a more flexible, market-based foreign exchange system has been on the agenda for the country's economic reform.

A more flexible exchange rate system will be important in improving the country's macro-economic adjustment system and in giving the market more influence in allocating resources, the central bank said.

In the short term, the move could have some negative effects on economic growth and employment. But the bank believes the overall benefits will outweigh any disadvantages.

The reform will alleviate the imbalance in China's foreign trade sector and spur Chinese enterprises to sharpen their competitiveness in the global market, it said. Chinese enterprises should readjust to the new situation after changes in foreign exchange rates, it said.

The central bank said it is a relativley good time for reform of the renminbi exchange rate mechanism as the Chinese economy has been growing rapidly.

The US dollar's exchange rate with the renminbi will be allowed to fluctuate by 0.3 per cent in the foreign exchange market. Fluctuation of other foreign currencies' rates towards the renminbi will also be limited within certain ranges.

The central bank would adjust fluctuating ranges according to the development of the foreign exchange market and the economic and financial situation, it said.

The central bank said it wants the yuan's exchange rate to be "basically stable on a reasonable equilibrium."

"Big swings in the renminbi's exchange rate will pose big impacts on the country's economic and financial stability."

The United States praised China's decision to move to a more flexible currency system.

"I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John Snow said in a statement.

China's move is regarded as a significant change by foreign analysts.

Immediately after the move, Malaysia said it was also unpegging its currency, ringgit, from the US dollar and replacing it with a managed float.

But Hong Kong said it would retain its currency peg with the US dollar. "The government has no intention at all of changing the Linked Exchange Rate system, which has served Hong Kong well for more than 21 years and has been the anchor of our economic stability," the city's acting financial secretary Stephen Ip said.

Lee Ferridge, chief currency strategist at Rabobank in London, said there was some surprise at China's announcement.

But "we were all waiting for it to come at any time. It's the biggest economic event of the year."

The following is the full text of the announcement published on the central bank? ˉ s website (www.pbc.gov.cn):

Public Annoucnement of the People's Bank of China on Reforming the RMB Exchange Rate Regime
July 21, 2005

With a view to establish and improve the socialist market economic system in China, enable the market to fully play its role in resource allocation as well as to put in place and further strengthen the managed floating exchange rate regime based on market supply and demand, the People's Bank of China, with authorization of the State Council, is hereby making the following announcements regarding reforming the RMB exchange rate regime:

1. Starting from July 21, 2005, China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB will no longer be pegged to the US dollar and the RMB exchange rate regime will be improved with greater flexibility.

2. The People's Bank of China will announce the closing price of a foreign currency such as the US dollar traded against the RMB in the inter-bank foreign exchange market after the closing of the market on each working day, and will make it the central parity for the trading against the RMB on the following working day.

3. The exchange rate of the US dollar against the RMB will be adjusted to 8.11 yuan per US dollar at the time of 19:00 hours of July 21, 2005. The foreign exchange designated banks may since adjust quotations of foreign currencies to their customers.

4. The daily trading price of the US dollar against the RMB in the inter-bank foreign exchange market will continue to be allowed to float within a band of 0.3 percent around the central parity published by the People's Bank of China, while the trading prices of the non-US dollar currencies against the RMB will be allowed to move within a certain band announced by the People's Bank of China.

The People's Bank of China will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation. The RMB exchange rate will be more flexible based on market condition with reference to a basket of currencies. The People's Bank of China is responsible for maintaining the RMB exchange rate basically stable at an adaptive and equilibrium level, so as to promote the basic equilibrium of the balance of payments and safeguard macroeconomic and financial stability.