The Institutional and Structural Problems of China’s Foreign Exchange Market & Implication for the New Exchange Rate Regime

interests are financial markets and corporate finance. After briefly reviewing the historical development of China’s foreign exchange market, we focus on the structural characteristics of the inter-bank market, describe its current structural problems as well as institutional constraints and explore the delicate relationship between foreign exchange market structure improvement and the reform of RMB exchange rate regime. We find the inter-bank market characterized by lack of market depth, limited transaction types, restricted participation with trading highly concentrated. The compulsory foreign exchange purchase and sale system distorts market supply and demand, and the rigid exchange rate regime reduces the Central Bank role to one of passive intervention. Two months after China’s foreign exchange market added eight foreign exchange pair to its inter-bank trading family, China’s central bank announced a reform of RMB exchange rate regime featuring a 2 % appreciation of RMB against US dollar and basket peg1. Regulator’s intention to diverge attention away from speculation on its exchange rate level and focus on improvement of exchange rate formation mechanism seems to have resulted in not infrequent moves to overhaul China’s foreign exchange market. The relationship between market structural improvement and reform of the exchange rate regime has 1 A more precise expression should be: determine the exchange rate level “with reference to ” a basket of currencies. The relatively stable performance of RMB/USD exchange rate since the July revaluation offers some hints that the central bank haven’t carried out a full basket peg yet and US dollar still dominates the determination of RMB exchange rate