Exchange Risk of China

CHAPTER 1 INTRODUCTION

1.1 BACKGROUND OF THE COUNTRY

The Socialist market economy of People's Republic of China is the world's second largest economy by nominal GDP and by purchasing power parity after the United States. It is the world's fastest-growing major economy, with growth rates averaging 10% over the past 30 years. China is also the largest exporter and second largest importer of goods in the world. As China's economic importance has grown, so has attention to the structure and health of the economy.

The Renminbi (RMB, sign: ¥; code: CNY) is the official currency of the People's Republic of China. Renminbi is legal tender in mainland China, but not in Hong Kong, Taiwan, or Macau. The primary unit of Renminbi is the Yuan.

Before 2009, the Chinese Renminbi had little to no exposure in the international markets because of strict government controls by the central Chinese government that prohibited almost all export of the currency, or use of it in international transactions. Transactions between Chinese companies and a foreign entity were generally denominated in US dollars. With Chinese companies unable to hold US dollars and foreign companies unable to hold Chinese Yuan, all transactions would go through the People's Bank of China. Once the sum was paid by the foreign party in dollars, the central bank would pass the settlement in Renminbi to the Chinese company at the state-controlled exchange rate.

1.2 REGIME OF EXCHANGE

For most of its early history, the RMB was pegged to the U.S. dollar at 2.46 Yuan per USD. During the 1970s, it was appreciated until it reached 1.50 Yuan per USD in 1980. When China's economy gradually opened in the 1980s, the RMB was devalued in order to improve the competitiveness of Chinese exports. Thus, the official USD to RMB exchange rate declined from 1.50 Yuan in 1980 to 8.62 Yuan by 1994, lowest ever on the record. Improving current account balance during the latter half of the 1990s enabled the Chinese government to...