Perhaps other suppliers in the zone would follow suit and would trigger a herd effect. Would the central bank see such a result as an unwelcome signal (for instance, for the export industry), biased, non-representative, dismiss it as a speculative outlier and even intervene in the zone to weaken the renminbi?

Or would it accept the rate as the nutshell result for what would happen outside the zone without central bank interventions and for what China will have to accept once the renminbi is internationalized? The three-year test period aims to find the answer.

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The uncertainty is large, both for the central bank and financial suppliers.

I do not believe the central bank will allow the Pudong renminbi rate to differ widely from the official rate. Financial suppliers are well-advised not to believe in a Pudong market rate exclusively determined by the markets rather than by the central bank.

The reason for my assessment is that in the coming years China will face two adverse effects in its industrial structure, which is still export-driven: An adverse price effect of trend-wise real appreciation and an adverse income effect of lower demand in international markets.

This will make the transition in employment from exports to domestic demand-driven industries more difficult. Jobs in the export industry will be wiped out long before new jobs in the latter industries will be set up. In this situation, a further push in real appreciation triggered by financial service suppliers will be regarded as unwelcome.

It would put into sharper relief the existing currency mismatch problem in China. China has returns in low-yield international currencies and commitments in local currency. An appreciation reduces the value of foreign reserves in the local currency.

So, as in the past, the Pudong zone will not be a free market for foreign exchange. China will rely on its past policies - and steps must be reversible. Trials are welcome, as are mistakes and missteps, so long as they are recognized and remedied.

The author is former vice-president of Kiel Institute for the World Economy, Germany. The views do not necessarily reflect those of China Daily.

 

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