Photographer: Nelson Ching/Bloomberg

China Must Give Up Peg on Dollar, Ex-Central Bank Adviser Says

  • China should clearly tell market its exchange rate policy
  • Yuan remains under depreciation pressure around Lunar New Year

A word of warning from a former adviser to the People’s Bank of China: Free the yuan from its dollar shackle and “clearly” inform the market of your exchange-rate policy to avert more damaging rounds of depreciation.

“It’s meaningless to peg the yuan against the dollar,” Li Daokui, currently a professor of Tsinghua University, said in an interview at the World Economic Forum in Davos, Switzerland on Wednesday. “The world is not in need of another currency that’s pegged against the dollar, it needs a relatively stable currency that’s pegged against a basket of currencies.”

In propping up the yuan, Chinese authorities have burned through more than half a trillion of dollars in foreign reserves in the past 12 months, cutting them to $3.3 trillion. The draw-down was almost equivalent to the entire stockpile of Switzerland, the world’s fourth-largest holder. Regulators also tightened capital controls, cracking down on illegal money transfers and restricting lenders from conducting some cross-border transactions.

Clear Policy

“None of these onshore or offshore intervening measures are ideal, the best way is to clearly tell the market what is China’s policy on the exchange rate and at what specific level the yuan should be pegged against a basket of currencies on a daily basis,” Li said.

The China Foreign Exchange Trade System, which is run by the central bank to facilitate interbank trading, last month unveiled a multi-currency index, spurring speculation that policy makers want to reduce the currency’s link to the dollar and let it weaken further.

The yuan’s peg to the dollar has become gradually looser over the past decade, since policy makers said in 2005 that the currency would be allowed to fluctuate against a basket of exchange rates.

The yuan remains under pressure, especially around the upcoming Chinese Lunar New Year -- in the second week of February -- because economic numbers aren’t showing clear signs of improvement, according to Li. Still, the larger size of the economy and its financial markets will make it easier for the government to manage its currency woes than during the 1997-1998 Asian financial crisis, he said.

“Let’s see whether the PBOC can win the war of stabilizing the yuan, which should be its top priority now,” said Li. “It’s much more important than the interest rate at this stage.”

Last bit of advise to the central bank? Bring under your wing the banking, insurance, and securities watchdogs to improve financial regulation.

— With assistance by Jun Luo

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