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The views expressed in this presentation are the views of the author and do not necessarily reflect the
views or policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB),
its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the
data included in this paper and accepts no responsibility for any consequences of their use. Terminology
used may not necessarily be consistent with ADB official terms.

Dynamic Transition of Exchange Rate

Regime in PRC and Its Influence on East
Asian Countries Exchange Rate Policies
Naoyuki Yoshino, Sahoko Kaji and Tamon Asonuma
ADBI, Keio University, and IMF SPR
October 2014
* This does not reflect any views of the ADBI or IMF.
2

Motivation
1, De facto dollar-peg regime in PRC and Malaysia until July
2005
- Basket-peg regime in Singapore (with a high weight on
the US$)
2, Change in exchange rate policy in PRC in July 2005
- De facto managed floating regime
- a trend of appreciation against the US$ since July 2005
- a substantial reduction on a basket weight on the US$
(from 1.0 to 0.814)
3, Malaysian ringgit and Singapore dollar followed a trend of
appreciation against the US$.
3

Main Questions
4, Is PRC better off shifting towards a basket-peg or a floating
regime over the medium term?
- How? a gradual shift or a sudden shift
5, Given PRCs shift in exchange rate regime, are East Asian
countries (Malaysia and Singapore) better off shifting towards a
basket-peg or a floating regime over the medium term?
5-1 How? - a gradual or a sudden shift
5-2, When? - before, during, or after PRCs transition period.

Literature Review
Desirability of a basket-peg regime in East Asia
- Ito et al. (1998), Ito and Ogawa (2002), Kawai (2002), Yoshino et al.
(2004)

Desirability of a floating (managed) regime in East Asia.

- Adams and Semblat (2004),

Exchange rate regime in E.A. with PRCs transition

- Shioji (2006), Gochoco-Bautista and Fabella (2006), Volz (2014),
Henning (2012).

Dynamic analysis in shift in exchange rate regime.

- Yoshino et al. (2014)
5

Chinese Exchange Rate (RMB) Fluctuations

8.5

Period 1 2003M1-2005M6

Period 2 2005M7-2008M6

Period 3 2008M7-2010M5

Period 4 2010M6-2012M5

8.0

7.5

7.0

6.5
Renminbi per US dollar
6.0

Sources: IMF IFS.

PRC

PRC

13

Quantitative analysis
Cumulative losses : T0=0, T1=18, & T2=18

14

Policy Implications
1, For a country like PRC, gradually adjusting to a basket peg
regime is superior to the other proposed transition policies.
- Advantage : it can minimize the negative influence of both
interest rates and exchange rates on output
2,A sudden shift to a basket peg is the second best solution, and is
superior to a sudden shift to floating.
- Drawback : a lack of control over the negative influence of
interest rates and exchange rates during the shift.
- Advantage : it can still assign optimal weights to currencies to
stabilize output fluctuations once it has adopted a basket peg
regime.
15

1 Chinese Exchange Rate (RMB)

Dollar Peg Imbalance in Current Account
Stability of Employment
Central Bank
----------------------US $ RMB
Euro (Cash)
Gov.Bonds (Reserves)

Private banks
-----
Reserves Deposits
Loans

2, Bubble
Bank loans to real estate and housing
16

PRC GDP, Bank Loan,

and Real estate Loan
1600

1400

Real estate Loans

1200

GDP2000
1000

LOAN2000

800

2000

600

400

200

0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

18

Bank Credit to Housing / GDPRatio

0.7

1.2

0.6
1.0
0.5
0.8
Japan
USA
09
20

07
20

05
20

03
20

01
20

99
19

97
19

95
19

93
19

91
19

89
19

87
19

85

0.3
19

19

83

0.6

0.4

19

Japanese Housing Price/National Income

20

US Housing Price/Income

21

Micro behavior of bank

and aggregated macro effect
Individual
bank loan

Japans Bubble (1986 1990)

U.S. Bubble

(2002 2006)

Aggregated
bank loans

Japans post bubble (1991 2001)

U.S. post bubble (2007 2010)
22
22

Influences on Exchange Rate Policies in E.A. Countries

(2) Dynamic Adjustment to the Basket-peg or

Floating in East Asian Countries after Chinas
Transition in Exchange Rate Regime
forthcoming as ADBI Working Paper

23

Motivation

Sources: IMF IFS.

24

Macroeconomic Model (cont.)

PRC

25

Annex: Macroeconomic Model

Small open economy model with three exogenous
countries
- following Clarida, Gali, and Gertler (2002)
- optimization behaviors of consumers/firms
- firms serving domestic markets and foreign markets (FCP) use
imported intermediate goods.

Transition of foreign country (PRC) - exogenous

- gradual adjustment of basket weight and degree of capital control
(Yoshino, et al. 2014)

Five exogenous shocks in the economy

- foreign real interest rate shocks (PRC, Japan and the US).
- PRCs risk premium shock / oil price shock
26

Annex: Macroeconomic Model (cont.)

IS

AS

Labor market clearing

Annex: Macroeconomic Model (cont.)

LM

Interest Parity Condition (JP & US assets)

Interest Parity Condition (Chinese assets)
Loss Function

Key Mechanism of Macroeconomic Model

Interest Parity Condition for PRC
- - expected risk premium
Exchange Rate and Basket Equation
(1) Dollar peg
(2) Basket peg

Transition Policies
PRC

30

Transition Policies (cont.)

31

Transition Policies (cont.)

PRCs

PRCs
PRC

PRCs

PRCs

PRC

32

Quantitative analysis
Data : Malaysia and Singapore
2000Q1-2012Q4 and IMF IFS/DOT
Cumulative Losses

PRCs optimal transition

policy
(Yoshino et al. 2014)

PRC

- gradual adjustment of
weight (to 0.58)
- gradual removal of
capital control.
33

Quantitative analysis (cont.)

- Smaller impacts on output gap due to Japan and US real interest
rate shocks under a basket peg (advantage of weights not fixed at 1)
PRC

PRC

PRC

PRC

Quantitative analysis (cont.)

- Positive impacts (though smaller) on output gap due to both Japan
and US real interest rate shocks under a floating regime.
PRC
PRC

Quantitative analysis (cont.)

(1) Malaysia
Stable regime
Adjustment
Basket weight
Cumulative loss (%)

Policy (1) Policy (2) Policy (3) Policy (4) Policy (5) Policy (6)
Dollar peg Basket peg Basket peg Basket peg Floating Floating
Gradual
Sudden
Sudden
Sudden Sudden
1.00
0.40
0.54
0.45
17.51
17.35
17.46
17.46
24.31
25.93
Sources: Authors calculations

(2) Singapore
Stable regime
Adjustment
Basket weight
Cumulative loss (%)

Policy (1) Policy (2) Policy (3) Policy (4) Policy (5) Policy (6)
Dollar peg Basket peg Basket peg Basket peg Floating Floating
Gradual
Sudden
Sudden
Sudden Sudden
1.00
0.9
0.67
0.85
45.60
45.56
45.64
45.61
60.51
64.18
Sources: Authors calculations

36

Conclusion
East Asian countries (Malaysia and Singapore) better off departing
from the current dollar peg regime to a basket peg.
Gradual adjustment towards a basket peg (during PRCs transition) is
the most desirable for E.A. countries as they could minimize the
negative influence of shocks during the transition.
A sudden shift to a basket peg (before/after PRCs transition) remains
as the second best solution for Malaysia, but not for Singapore.
A sudden shift to a floating (before/after PRCs shift) results in higher
cumulative losses than maintaining the current dollar peg for both
Malaysia and Singapore since volatile exchange rate fluctuations lead
to higher output gap/inflation rates.
37