May 23,2010

Perfect Time for RMB/USD Rearrangement: Devaluation

By Xu Yisheng, Beijing

The time to restart the reform of the RMB exchange rate formation mechanism is now. Monetary authorities should not be misled by opinions of "euro crisis leading to foreign exchange reform."


Three misunderstandings need to be clarified.


The first is that the RMB exchange rate has been stable since July 2008. In fact, the RMB/euro exchange rate has changed dramatically since July 2008 due to the USD volatility against the euro.


Second is that "RMB appreciation" means "RMB appreciation against USD." The fact is that since the end of 2009, the RMB/USD rate has remained stable because of the sharp rise in the dollar index, while RMB against a basket of currencies has appreciated substantially. The euro, for example, is currently at 1/8.3 yuan, the highest level for the past eight years.


Third is that keeping the RMB exchange rate at a reasonable and balanced level means to maintain the stability of the RMB/ USD rate. What it really means is to maintain the stability of RMB against the basket of currencies, and the basic stability of an effective exchange rate.


After we clarify such misunderstandings, we must redefine the objectives of RMB reform, i.e. to promote the formation of a mechanism for a more market-oriented RMB exchange rate. The conception that RMB/USD appreciation is the same as RMB exchange rate formation mechanism reform is wrong and misleading.


Against the strong rise of dollar index, and following a basket of currencies mechanism, RMB may have to depreciate against the US dollar to ease its appreciation against other currencies.


Since 2003, the greatest obstacle to RMB exchange rate reform has been the expectation of unilateral appreciation of RMB against the dollar. Now would be a perfect time to respond to the wrong expectation through the devaluation of RMB against the dollar. Only in this way can excessive speculative capital inflows be avoided.


It is only when the dollar index rises that the market provides such a window to RMB. When the US dollar depreciates against major currencies, the expectation of RMB against the dollar becomes stronger, and there exists no market environment devaluation.


Time slips away, and so will this opportunity. The first chance, from July, 2008, to March, 2009, has already come and gone. At that time, the dollar index rose, and there existed devaluation expectation in the RMB NDF market in Hong Kong. However, RMB was pegged to the dollar rather than allowed to depreciate following market expectation, while the currencies in India, Russia, South Korea, and Brazil depreciated 20%, 40%, 50%,and 50% against USD, respectively.


Now we are in a second widow. The reform of RMB exchange rate formation mechanism in July, 2005, marked the change from the RMB peg to the dollar to a reference to a basket of currencies, but conditions have pushed that to the side. RMB has returned to its dollar peg, and that does not meet the basic structure of Chinese trade.

It is the perfect time for the devaluation of RMB against the US dollar, easing its appreciation against other currencies such as the euro.


(The author is the staff contributing writer for

Click to Get New TextCan't read this text? Please click the image!
Please verify the text in the image.