Article

China: More Flexible Exchange Rate Could Assist Monetary Policy

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
October 2006
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China is continuing to grow rapidly, according to the IMF’s recent review of the economy. GDP growth reached 10 percent in 2005, roughly the same as in 2004, and is projected to grow at that level in 2006 and 2007. Net exports and investment continue to expand rapidly, and strong world demand and China’s increasing role in global processing trade drove export growth. A slowdown in import growth resulted in a current account surplus of more than 7 percent of GDP, up from 3½ percent in 2004. Despite some tightening of monetary policy and administrative controls, investment growth continued to be strong. The recapitalization of three large state-owned commercial banks has improved bank operations. State-owned enterprises have become more market oriented, and corporate and management restructuring has continued.

China
Proj.
2003200420052006
(percent of GDP)
Real GDP10.010.110.210.0
Consumer prices11.23.91.81.5
(billion dollars)
Exports438593762937
Current account balance4669161179
Gross official reserves24126198261,046

Period average.

Includes gold, SDR holdings, and reserve position in the IMF.

Data: Chinese authorities and IMF staff estimates and projections.

Period average.

Includes gold, SDR holdings, and reserve position in the IMF.

Data: Chinese authorities and IMF staff estimates and projections.

Discussing the IMF review, Executive Directors commended the authorities for sustaining high economic growth. They broadly supported the government’s medium-term economic reform strategy, particularly the need to rebalance the economy away from heavy dependence on investment and exports for growth, and toward consumption. Additional monetary policy actions are needed, particularly by stepping up open market operations to drain liquidity from the banking system. Directors emphasized the importance of improving monetary policy effectiveness, noting that, although moral suasion and administrative steps to restrain credit and investment growth are necessary, such measures can make it difficult for banks to operate fully on a commercial basis. Early reform of the Agricultural Bank of China, the last of four large state banks, is needed to further improve overall banking operations.

Greater exchange rate flexibility would enable the People’s Bank of China to use its monetary policy instruments more effectively. Many Directors consider it appropriate for China to increase exchange rate flexibility in a gradual and controlled manner, understanding that acceleration could adversely affect macroeconomic stability. A number of other Directors stressed that the flexibility afforded by the current exchange rate system should be used more extensively because the current strength of the Chinese economy provides a favorable context for adjustment.

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