The Future of China's Exchange Rate Policy (Policy Analyses in International Economics 87)

Over the past five years China has emerged as the world's largest global surplus economy; indeed, by 2007-08 the size of its surplus relative to its GDP was of a magnitude unprecedented for a large trading economy. This development is especially surprising since in the first twenty-five years of economic reform China's trade and current account surpluses were quite small by East Asian standards, averaging less than 2 percent of GDP. This study provides a comprehensive analysis of the key economic challenges facing the Chinese authorities in light of the still undervalued exchange rate, the large build-up of foreign exchange reserves, and more recently the sharp decline in economic growth. It analyzes the implications of China's exchange-rate policy for the effectiveness of monetary policy, the transition to a commercially oriented banking system, the evolving structure of output and demand, and the risk of protectionism abroad. The policy-options portion of the study will take account of the significant real-effective appreciation of the RMB over the past fifteen months and will contrast the pros and cons of a stay-the-course policy with that of a bolder, three-stage approach that would seek to maintain recent progress and to reduce even further the undervaluation of the RMB.