Monetary Policy in China

in Currency Market

When China’s monetary policy is analyzed, one thing stands out presently – there is a continued incline in importation of products into China at a rate higher than the exports growth. Secondly, after the peg of the Chinese Yuan to the dollar, the Chinese currency’s real trade-weighted value declined. This is notable mostly since the beginning months of 2002, at a time when the US dollar reached its peak value.

China is a great economy in the making. At this point in time, the metrics of China’s currency are largely undervalued and others unlisted. China’s Current Account has been growing at a steep surplus since 2007. For instance, the current account ran at US$17 billion last budget year as compared to US$4.6 billion in 2001. That is giant leap in just six years. This ensues in a 1.5 percent growth in Gross Domestic Product, an outstanding feat for such a massive economy. To realize how big the growth is in China, as other countries go under in the global economic crises, let us compare two more years, 2003 and 2004. China’s economy ran a trade surplus on the Current Account, of an amazing US$32 billion in the year 2004 as compared to a surplus of US$25.5 billion in 2003.

This is indicative of some thing being done right in China’s economy. Experts feel that this kind of growth rate is unsustainable due to the heightened pace as evidenced by the resultant unprecedented public demand for imported products as substitutes of locally processed ones. In 2003 alone, China’s imports rose by 40%. These two factors make China a rich ground when it comes to money making potentials. Investors are therefore watching with anticipation, some are already there and making the kill.

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A prominent analytical framework used by experts to examine and evaluate a nation’s balance of payments is called the underlying balance approach. The underlying balance, usually on the Current Account of the country, helps to identify the equilibrium of the nation’s exchange rate. This results in the overall equilibrium of the balance of payments. Practically speaking, when the normal capital inflows are added onto the underlying Current Account, the resulting sum should be equal to zero. The IMF uses this approach when determining the exchange rates of a country’s foreign trade and currency trading. Although China’s monetary policy and economic administration has come from far, although the economy is doing very well, on this particular metric of underlying balance approach, China’s current exchange rates in preceding years have been far from the equilibrium, but China is getting there soon, predictably.

One thing commendable about the Chinese money market is that it has remained on a surplus capital account year after year, since the financial crisis of Asia. In the years 2003 to 2008, China had exceptionally huge capital inflows. Experts read this to indicate a market expectation of lucrative foreign exchange. In essence, the result is a currency rate appreciation, which can happen independent of underlying economic policy fundamentals. As such, experts feel that although promising, the China monetary market needs policy frameworks to support it in this age of unprecedented growth, since the existing policy has been outlived by growth. Investors therefore are still regarding China as a volatile market, since the appreciation there has more or less been facilitated by goodwill, virgin markets, new institutions and new markets outside the country, and not by monetary policy as such.

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When we consider China’s policy on exchange rate, a basic question that reverberates across the board is why China has not yet revalued her currency. China’s case is not as straightforward as it might seem from the outset. China is indeed a classic example of a state failing to revalue her currency while in the heat of a huge external surplus. This mostly happens when there is a conflict of interest between several domestic macroeconomic goals and economic objectives. China’s monetary policy finds itself faced with an economy that has a fixed foreign exchange rate matched to a weak external market position and dominance.

[ad#downcont]As such, the monetary policy in China would typically be reluctant in revaluing the Yuan during this period of weak international aggregate demand for her products and currency. It is expected therefore that China’s monetary policy will wait for a larger market presence of Chinese products and or Chinese currency in the world market before revaluing the Yuan, since at that time, the demand for the Yuan would be a bit higher than it is at present. Revaluation at this time would increase the demand for domestic imports within the economy while simultaneously reducing the world demand for China’s exports.