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Although some progressive steps have been taken by the Chinese government to add more breadth and depth to China’s capital markets (e. g. the permit qualified foreign investors to list on the Shanghai exchange in 2010 and approve banks to issue renminbi-denominated corporate bonds), it will take some years before the Chinese capital markets can successfully be reformed to a more open and mature stage.
Although China is ranked 3rd worldwide in absolute economic size, it remains far behind other leading economies in average per capita income level. For example, in 2007, China per capita income was equivalent to US$2,342 and is projected to be US$49,650 by year 2050. However, China will still lag far behind when compared to the U.S. which is projected to have a per capita income equivalent to US$91,683 by 2050.
In addition to the “physical” fundamental factors essential to the internationalization of a currency, there are also the “psychological” factors that play a supporting role. For instance, a stable currency will be more acceptable as an international currency, in the viewpoint of an investor, than a volatile one. The stability of a particular currency can be measured by its home economy’s inflation rate and the acceleration of it undermines the purchasing power of that currency. For example, China has a low average annual inflation rate (1.1%) when compared to the U.K. with 2.8%, U.S. with 2.6%.
Another important measure of currency stability is the unit’s exchange rate volatility. This can be calculated as the standard deviation of daily percentage change in the exchange rate against International Monetary Fund’s Special Drawing Rights. A calculation done by Wu yielded an average of 4.4 for the renminbi during a period of 10 years. This is low when compared to the dollar (4.5), euro (5.4) and yen (8.2) respectively (see figure 4). Currently, the renminbi lacks the primary prerequisite to become a global currency: free and full convertibility.
Numerous workers fear that goods and services are being moved overseas and taking jobs with them contributing to an increase in unemployment. Businesses that manufacture exportable goods and services and/or compete with imported goods and services view weak exports compared to imports as damaging state of affairs to both competition and local economy. For example, the U.S. largest bilateral trade imbalance is with China. However, if the RMB is undervalued, the exports from China to the U.S. are likely to be cheaper than they would be if the currency were freely traded. This will provide a boost to China’s export industry and attract for foreign investment.
In this paper we focused on the reasons and effects of the Chinese exchange rate reform (Yuan appreciation). We explained and assessed Hu Xiaolian’s claims about the reform of China exchange rate system and explored the possibility of the Chinese Yuan becoming a regional trade currency. In summary: Inflation rate is a key exchange rate determinant and because of its dynamic evolution, it has implicated the assessment of a sensible RMB/USD exchange rate movement. The exchange rate reform will help China monetary authority manage the level of exchange rate that will contribute to a more market-determined exchange rate on the long run. The exchange rate reform will help China resolve its trade imbalances through shifting economy dependence on a more domestic demand for growth. The Chinese currency still lacks the primary prerequisites to become a global currency.