Exchange Rate Policy and Balance of Payments in China
The main function of the Peoples Bank of China is to set exchange rates for various foreign currencies. These two aspects create a frame work that shows how China uses specific policies in exchange rates that has contributed to trade surplus. Trade deficit in China with its trading partners is a major challenge that is addressed by the adoption of good exchange rate policies. Large external surplus reported in China in the recent decades is an implication that its exchange rate is undervalued. The United States is one of the major trade partners that have helped China to develop economically and technologically. Through implementation of good exchange rates policies, China can now boast of a trade surplus that is associated with exportation of goods. Political stability is a key player that led to economic growth and development in China. Strong political organization in China made its economy to overcome balance of payment problems (McKinnon, 2009).
Exchange rate policy in China
Peoples Republic of China uses Renminbi (RMB) as their official currency and is issued by Peoples Bank of China. In the recent decades, US dollar was pegged at 8.28 RMB but it gained value due to pressure from World Economic Council. China wanted to maintain the exchange rate of Yuan against dollar stable so as to create a good economic rationale. Maintenance of an exchange rate that is stable served as one of the most important monetary anchors for price level in China. Exchange rate policy helped China to regain stability in price level after several years of inflation that exploded in the various periods (Lardy, 2005). Measures are underway in China to make sure that exchange rate is maintained at a stable position that helps the economy to grow at a very high rate. Pressure from the United States was very intense and this resulted to revaluation of Renminbi against foreign currencies. The policies adopted by Chinese authorities led to appreciation of renminbi but this was a challenge to private capital outflows. The appreciation of Chinese currency led to prevention of Chinas trade surplus from being financed by private capital outflow (The Economist, 2009).
Financial institutions like banks in China refused to buy assets at low value of dollar but international inflows were compounded to buy renminbi assets at higher value. This was a major challenge to investors in China and authorities acted fast to adopt policies that prevented renminbi from appreciating further. Peoples Bank of China acted fast by selling renminbi and buying dollar assets and this made Renminbi remain at a steady state. The efforts by Peoples Bank of China did not bear good results as were expected. The excess in domestic money led to increase in inflation rate that happened between 2006 and 2008 (Garcia, Koivu, 2009). This was time of economic crunch in the United States and after the crisis, a dollar that traded badly appreciated within a short period of time. The appreciation of dollar led to revaluation of renminbi that was pegged against it and this policy made Peoples Bank of China to have control on reserve requirements and inflow control on many commercial banks in China. In the recent decades, there has been flow of private capital to finance trade surplus in China which has led to the fall in official exchange reserves. Below is a diagram showing the relative strengths in the exchange rates by various economies.
(Retrieved on 17th February 2010 from, The Economist, 2009)
Chinas exchange rate policy is considered to be one of the major factors that have led to the end of China bashing that is considered to be more than a political issue. Changes in the exchange rate cannot be used to control trade balance within the economy of China. However, it was believed that revaluation of renminbi against dollar could not be effective to reduce American trade deficit and China trade surplus. The increase of trade surplus in China can be attributed to investment slump due to appreciation of the renminbi (Goldstein, 2004). The exchange rate policy in China has led to domestic saving that is needed to finance domestic investment. The major economic challenges that faced China in the past decades were inflation and overheating. Inflation in particular made Chinas exchange policy to turn down the plans of investors and this has been a major challenge that Peoples Bank of China is working on.
Balance of Payment in China
Balance of payment includes recording of monetary transactions that occur between a country and other countries in the world. The transactions include payment of exports, financial capital and imports of goods or services. It is a summary of all international transactions within a given period of time and is basically prepared in the domestic currency of the concerned country. The main interest of this research paper is balance of payment in China and the major factors that contributed to its stability (Huang, 2009). One major factor that affects balance of payment and exchange rate stability is political structure in China.
(Diagram showing the trade balances in China reflected in terms of million US Dollars as shown by the blue graph against the existing levels of economic recession in its economy as reflected by the gray shading. Retrieved form, httpwww.econbrowser.comarchives200907three_pictures_4.html
Politics play a very important role in determination of balance of payment which is more superior to economic freedom. China has a political structure of one party that has led to appreciation of Yuan due to political stability. One party political structure gives Chinese people the capacity to create an environment for investment, saving, importation and exportation of goods. This leads to creation of a balance of payment that favors surplus balance of payment and high levels of international reserves (Cappiello, Ferrucci, 2008). However, the degree of political stability in China contributed to disequilibrium in the balance of payment but good exchange rate policies have overcome this major problem.
In the recent decades, China had a surplus in current accounts due to increase in exports and minimum imports that were experienced at the same time. Some sectors such as tourism, shipping and remittances from Hong Kong led to current account surplus of 4.2 billion in 2008. There was a capital reserve deficit that resulted from four modernization policies in China. The authorities decided to cancel contracts with other countries such as Japan and other western nations due to a problem of cash flow. In addition, reordering of investment projects according to their priority was a major challenge that resulted to cancellation of high level contracts (Goldstein, 2004). These problems forced Chinese authority to develop a policy of exchange rate that was manageable. A development occurred in trade account that was helped out by a steady rate of exchange policy which enabled a surplus in balance of payment.
The adoption of trade account policy led to increase in the level of foreign investment and income from tourism sector. China created a reserve that was used for development in various sectors such as infrastructure and industrial projects. In the late 1999, goods in China had no market because of low domestic demand leading to losses for the respective parties involved in business. The low domestic demand forced traders to find market from external markets so as to maintain balance of payment and avoid loss of income (MacKinnon, 2009). In addition, China signed trade agreement with World Trade Organizations so as to counter the impact of low domestic demand leading to dependence on foreign trade.
Conclusion
Chinas exchange rate policy and balance of payment in the recent decades has contributed to both economic and technological development. Political stability, level of exports and imports has led to creation of a strong relationship between China and other foreign nations. The exchange rate policy helped Chinese currency to be strong against other foreign currencies. This is a major achievement in the development and achievement of a reserve accounts that help China to undertake various projects without strain.
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