The Costs and Implications of PBC Sterilization

Abstract

Since China revalued its currency against the U.S. dollar by 2.1 percent in July 2005, from RMB 8.27 per US $ to RMB 8.11, the RMB has appreciated by a further 14 per cent percent to about RMB 6.97 per US $ (as of May 2008). On a trade-weighted basis, however, the currency has appreciated less than half this amount. Using J.P. Morgan’s trade-weighted index (broad basis) for the RMB, the currency appreciated just 6.1 percent in nominal terms between August 2005 and May 2008. Although the currency has been very gradually appreciating, the flexibility promised by China’s leaders has been more illusory than real, and, more importantly, the underlying international payment imbalances have continued to widen both in absolute terms and as a fraction of GDP. In this article, I set out the magnitude of the problem of China’s international payment imbalances, summarize the techniques used by the People’s Bank of China to sterilize China’s overall balance of payments surplus, and assess the costs and benefits of the PBC’s ster-ilization strategy—both from a theoretical perspective and in the light of the experience of other East Asian currencies that have wit-nessed large-scale sterilization operations in the past. I also consider whether, for the purpose of ensuring satisfactory monetary arrange-ments in the 21st century, it is appropriate for a country of the size and stature of China to delay adjustment by means of large-scale sterilization.