China reforms exchange rate

CHINA is to drop its two-tier exchange rate system that penalises foreigners. From Saturday the exchange rates will be unified and the currency - the yuan - will be allowed to float.

Yesterday's announcement by the People's Bank of China makes more credible the country's ambitious plans for reform of its financial systems. It also improves China's chances of rejoining the General Agreement on Tariffs and Trade and pulls the rug from under the thriving currency black market.

The decision to unify amounts to a 50 per cent devaluation in China's official exchange rate. Zhou Zhengqing, vice-governor of the People's Bank, the central bank, told state radio and television: 'This lays a foundation for the yuan to become a convertible currency in the future.'

The most immediate visible impact will be on the notorious Foreign Exchange Certificates that all foreigners are supposed to use instead of the renminbi (people's money). The FECs have in practice been a device to extract an unrealistic exchange rate from foreign visitors, businessmen and residents as they must be purchased at the official exchange rate of about 5.7 yuan to the US dollar.

The market-driven rate at China's limited business-oriented 'swap' centres and on the black market is about 8.7 yuan, which is the best indication of where the new official rate is likely to start.

Last night the black market in FECs collapsed and the banks are today likely to be flooded with people trying to convert FECs back into hard currency.

The fixed official yuan rate was a legacy of decades of Communist central planning. Its removal, after years of premature rumours of its demise, is a key decision in China's market-oriented economic reform under Deng Xiaoping.

It represents a political triumph for Zhu Rongji, the reforming vice- prime minister, who has been battling party hardliners to modernise China's financial systems. From now on the central bank will keep exchange rates stable by intervening in the market and using monetary and interest rate policy.

As well as removing an irritant for tourists, unifying the exchange rates will hit any state-owned enterprises that still buy their hard currency at the official rate. However, the government had earlier this year already started making state companies use the swap market rate. The impact on foreign investors who trade with China will also be limited because about 80 per cent of trade-related foreign exchange dealings are already placed through the swap markets.

In international financial markets the move will be welcomed. China had already promised Gatt that the yuan would be fully convertible within five years.

For ordinary citizens, who would love to convert renminbi savings into dollars, access to foreign exchange will still be difficult. Even enterprises will have to show import licences and contracts if they want to buy foreign currency.

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