China Monetary System - Coursework Example

University

Introduction

The amazing growth in China export, at the expense of other nation’s market share has heightened discussion about its monetary system. In fact, China, as the world’s largest consumer market and growing export power, its decision regarding its monetary policy is largely monitored by all countries in the globe. China is linked with almost all countries in the world through its interconnected export and import chains, and this heightens the need to closely monitor its monetary policy. In this regard, it is essential to examine China’s monetary policy. Hence, the following article analyses China monetary policy, particularly: the evolution of its monetary system, and the effect it has on trade and fiscal policies: the key elements of its financial system, including organizations and financial system: its currency exchange policy and its effect of exchange rates: and, issues relating to economic exposure, transaction exposure, and translation exposure. Finally, it would offer appropriate recommendations to investors whether to purchase or sell options or futures in Renminbi or Yuan.

Analyse the progress of China’s monetary system, and include its effect on trade and fiscal policies.

The evolution of currency in China can be traced back three thousand years before the birth of Christ. In 3000 BC, the indigenous inhabitants used copper as a medium of exchange. Afterwards, silver ingots, gold cubes, and cowry shells were later adopted as a medium of exchange (Cheung, Ma, & McCauley, 2011). Cowry shells started being used as a medium of exchange from 24 BC to 20 BC, and then gold was adopted. However, it is not until 11 BC that Chinese government adopted a greater role in managing money. In the following years, salt, metal shaped cowry shells, bronze money in the shape of spade, bronze knives, and small coins with holes at the centre were adopted as standard of payments. However, during the reign of Hien-Tsung from 806-821 AD china issued its first paper currency (Chi, 2016). China was the first nation to issue paper currency in human history. In 1889, China adopted its first western-style mint, which issued silver dollar notes. In 1897, the imperial Bank of China, opened and issued government paper. However, soon afterwards many private banks sprout-up and developed their currencies. It was not after revolution that the country developed its first national monetary system, with a standard legal tender (Koivu, 2012). However, the initial development of monetary policy can be traced back to 135 BC, where the government, scholars, and thinkers entered into negotiations to determine whether private enterprise should be determined to coin, or if it the sole rights of the government to hold and supply currency. The government outlawed private coinage of its currency; but, it underwent a period of legal and prohibition over the years.

The Chinese currency, Renminbi (RMB) has been under circulation for over six decades. Also, known as the Chinese Yuan (CNY) is a distinct between the offshore and onshore markets. Hence, it is one currency; but, has two systems. The onshore market system is abbreviated by the CNY code, and it is largely dependent on government policy (Thorbecke, 2011). On the contrary, the offshore system is denoted by CNH code, and it is tradable in major financial centres, such as, Singapore, London, and Hong Kong. The utilization of the Yuan opens up more business opportunities, as it diminishes the FX risk, and enables a larger access to a larger pool of buyer and sellers. China has prudent fiscal policy environment that is characterised by modest fiscal deficit, and low levels of federal government debt. The government has reduced its interest rates to help open up the country’s credit levels, and it has significant foreign reserves in its system. Thus, in any deterioration of the economic situation, China is likely to switch to stimulus mode. Thus, paying in Yuan offers firms a greater price transparency and reduced costs (Chi, 2016).

Illustrate major elements of China’s monetary system, and include financial and organizational institutions.

Regardless of different cultures, Chinese monetary system is largely similar to the major monetary systems in the world. The only difference is the way they are implemented. The main objective of the Chinese monetary system is to foster growth through fighting inflation and raising credit by tightening fiscal policies. The key component of the monetary system is the interest rates. The People’s Bank of China (PBOC) establishes the interest rates, which other financial and banking institutions charge. Furthermore, the PBOC controls and establishes all types of rates including lending and dumb rates (Koivu, 2012). The lower limit relates to surplus reserves needed, whereas the upper limit relates to lending rates. The unperturbed IR is the discount rate and rediscounts that are essential techniques in the Chinese monetary system. The rediscounting rate is recognised as the Central Bank‘s benchmark lending rate. The PBOC uses the interest rates to control the supply and demand for money by influence the rate offered by banks and other financial institutions to offer credit. In recent times, the PBOC has relaxed its interest rates, in attempts to reduce the country’s base lending rates, and boost its credit facilities (Thorbecke, 2011). The PBOC is re-instituting limits of its interest rates, and dumping its financial liberalization strategy to strengthen its banking industry to encourage loan write-offs in the face of growing bad loans. The Chinese deposit and lending rates is complex as they divided into upper and debase limits. The reduction of interest rates indicates that the country adopts an expansionary policy. The price based components of the monetary system are minimum requirement and open market operations (OMO) (Xing, 2012). The Central Bank, PBOC, can utilise open market operations, or interbank market to buy and sell its currency. Also, the PBOC maintains certain designated or selected foreign exchange banks to function on its behalf for local spot market activities. The Chinese minimum reserve requirement has been gradually reducing to cushion the country against economic slowdown; however, at 17% is still one of the highest in the world. The Central Bank, PBOC, has other components of the monetary system, such as, the derivative contract, which it uses to influence the value and market of the currency. The adequate combination of these instruments results in more complication in the management of foreign reserves and rate of its currency. However, the key benefit is that the Central Bank, PBOC, does not have to sell its huge dollar supplies suddenly, and hence, this reduces the depletion of its reserves. Hence, maintaining a market confidence in its ability to intervene, in case of market uncertainty in the future (Cheung, Ma, & McCauley, 2011).

Illustrate the exchange rates and any important effect on the exchange rates.

The Chinese exchange rate system is described as a floating system, recognised as the managed float. The managed float is categorised within the floating regime because market forces ascertain the direction and trend of the currency (Koivu, 2012). However, its floating system is a unique approach, where it re-value’s its currency based on a system of basket of currencies, which are the Euro, the Korean won, the Japanese Yen, and the dollar. In spite of its managed floating system, the Yuan is traditionally pegged against the United States Dollar by the PBOC. The PBOC has introduced measures to attempt to stem the economic slowdown, and one of it entails reviewing its monetary policy to reflect its short-term monetary policy needs. For instance, the Central Bank, PBOC, offers a daily-pegged reference rate to the dollar (Thorbecke, 2011). This has undermined its ability to attain stability in the exchange rates; particularly, when the country is attempting to integrate itself into the global market system. The Chinese exchange rate policy is undervalued. China maintains a low currency exchange policy in order to boost exports by making it more competitive and raise demand, and restrict imports. The economists predict that the PBOC has undervalued its currency at about 15% to 40% of the United States Dollar. It is worth noting that china’s devaluation strategy is done against all the global world currencies (Xing, 2012). This has a significant impact on the exchange rates, as it makes the Yuan lower in value in comparison to the other world major currencies, or its trading currencies. China’s approach makes the United States Dollar more expansive than the Yuan, and this keeps Chinese product cheap at the international markets. A stronger United States currency raises the China’s ability to purchase more products across the world. China, by making other global currencies relatively expensive, it discourages its people from purchasing imported products, including India, Europe, and the United States, because they are relatively expensive. Hence, as a result, China restricts its balance of payments with almost all its trading partners, if not all, which raises its trade deficits (Chi, 2016).

Analyse issues around economic exposure, transaction exposure, and translation exposure.

China’s economic exposure is relatively moderate, as it has trade surpluses with Europe and United States, it largest trading partners. However, it operates a trade deficit with ASEAN countries, Brazil, South Korea, and Russia. Regardless, the country has an overall trade surplus of $49 in October 2016. Additionally, it is currently experiencing an economic slowdown based on its transition from an export-led to a market-based economic model, and this has caused a slowdown in economic activities (Chi, 2016). The level of translation exposure in China is low, as its financial reporting standards, China Accounting Standards (CAS) , are largely in line with International Financial Reporting Standards (IFRS), with little discrepancies. The difference between CAS and IFRS is asset revaluation (Miao, 2016). Asset revaluations are not allowed in China, unless in business combinations while in IFRS it is permitted based on fair value or historical cost. The level of transaction exposure has a moderate to low transaction exposure, based on its surplus balance of payments. However, the lack of stability in Yuan, as a result of daily reference rate, which is largely unpredictable, and the devaluations of its currency complicate circumstances, as it raises the level of inflation, and the costs of imports (Miao, 2016).

Recommend to investors whether they should buy or sell futures or options in that currency.

The Chinese Yuan has been gradually appreciating its value, as a result, of the country easing of Interest rate, and change in economic approach, from export-led to market-led economy. The country has been experiencing a slowdown in economic activity, as a result of structural change; however, the country will continue to grow. Furthermore, the Yuan offers a lower level of forex transactions risk, and hence, it offers a suitable investment options for investors.

Conclusion

China monetary policy is undergoing significant policy shifts and changes, as the country aligns itself to become a market based economy. The country’s monetary policy is a complicated system, which is one currency, and two system based approach; however, this system offers investors and companies lower level of forex risk exposures, and thus, it is suitable forex trade and investment. China’s exchange rate system is recognised as a floating rate system, which is based on system that establishes daily reference rate by revaluating four currencies, which are: Euro, the Korean won, the Japanese Yen, and the dollar. The country undervalues its currency to shore up its much needed exports, and raise the value of imports in its local market, and this, raises it trade of balance accounts. Its devaluation strategy discourages its people from buying import goods, as they are highly priced than the local produced goods. As a result, China has trade balances accounts. The country’s level of translation exposure, economic exposure, and transaction exposure are relatively low, and hence, it offers a good opportunity for investors to invest in future and options based on the Yuan. Furthermore, the dual-based system of the Yuan offers significant opportunities for investors to lower their FX risk exposure, and this, enhances opportunities. Furthermore, china has a prudent fiscal policy that has a low federal debt and fiscal deficit.