Question

The United States and the European Union have been pressing China's government to alter its exchange rate policy to allow more flexibility, presumably so that the yuan will appreciate by a substantial amount. What has been and are China's policies toward the foreign exchange market? From the point of view of China's government and the well-being of the Chinese economy and people, what are the main reasons for the Chinese government to allow more flexibility and (probably) substantial yuan appreciation? What are the main reasons for China's government to maintain its current exchange rate policy?

Answer 1

China's policy towards the foreign exchange market is to keep the rate of yuan undervalued to promote their exports. The Chinese yuan is not flexible enough and doesn't respond well the market forces. The Chinese government keeps it undervalued i.e. the price of their exports cheaper in other countries.

If the Chinese government allows more flexibility the Chinese central bank will have to spend a lesser amount of dollar in the open market to maintain a fixed exchange rate. The people living in China can buy imports at a much lower price and the Crude oil prices which the Chinese import from other countries will come down benefiting the consumer in the economy. An undervalued currency is not sustainable for a long time if China continued the tactics to promote exports in an unfair manner it would promote other nations to retaliate.

The Chinese government does this to promote exports and maintain a predictability for the investors in the export market.