Hu Xiaolian, deputy governor of the People's Bank of China (PBC), has re-affirmed her country's commitment to a more flexible currency regime, and looks forward to a day when the central bank would be able to 'let the market decide' exchange rates.
Her comments come as G7 finance chiefs prepare to issue a statement tomorrow that will recognize China's currency reforms.
In an interview with Emerging Markets ahead of the annual meetings Ð where China's exchange rate reform is high on the agenda Hu, who is also head of the State Administration of Foreign Exchange, cast the country's recent adjustment of its exchange rate regime as 'a substantial step forward,' which will 'definitely reflect market supply and demand.'
That change, however, will not take place immediately. 'We can't expect the move will change the activity or strategy of the PBC in the foreign-exchange market overnight,' Hu said. But she indicated that China is now moving away from the market interventions it has relied on in the past toward a much freer policy, if slowly.
'Gradually the PBC will carry out fewer and fewer interventions in the foreign exchange market, and let the market decide,' she said. 'The frequency and level of such interventions will be gradually decreased.'
China's move on 21 July, which freed the yuan from its dollar peg and fixed it instead to an exchange-weighted basket of currencies, allowed the yuan to appreciate 2.1% against the dollar, and 'paved the way to a more flexible exchange rate regime,' Hu said.
However, she added: 'We think it's still an open question as to whether the RMB exchange rate is undervalued.'
Hu indicated that the policy shift is part of a broader change, including the diversification in reserves composition of recent years. As a result, an adjustment in the level of US Treasury bonds that China purchases will not be necessary, she said.
But the PBC seems to be maintaining its defensive stance on ad hoc exchange-rate operations. One danger for China under the new exchange-rate regime will be inflows of speculative capital that could unbalance the economy. How this might be dealt with remains to be seen.
'We should first further develop our capital markets and other domestic institutions, to better use our domestic market to finance business,' Hu said. 'We have to implement all kinds of control on this hot money. We have to keep our watch on capital inflows.'
The perception that the People's Bank is still able to maintain a stable exchange rate will be the key to heading off speculative capital inflows in the first place, Hu said. 'We've repeated this many times: a stable exchange rate is in China's best interest.'