Renminbi exchange rate and capital flows interactions in China

The rmb’s exchange rate plays a very important role in china’s economic development,more so as the country relies heavily on foreign trade. as rmb’s exchange rate regime changes from a fixed exchange rate regime to a completely free floating one,china’s plan to open capital accounts is in the pipeline. evidence point to a relationship between rmb’s fluctuation and capital flows. this paper uses vector auto-regression (var) model to evaluate the relationship between rmb’s fluctuation and capital flows. combined with the actual situation in china,this study introduces the exchange rate expectations (ndf),gross domestic product (gdp) growth,and interest rate factors into the model. in the past two years,rmb’s rate regime reform has moved fast,and the benchmark interest rate and repo-bond’s rate are not reflective of the market’s true rate. therefore,the currency market’s rate gap between china and the usa is used in the var model as rate variables. the results show that the rate variable has a high degree of influence on both exchange rate and capital flow. rmb exchange rate’s fluctuation has an influence on capital flow,however,it is not considered significant,especially in relation to the spot exchange rate. this phenomenon is largely due to the intervention of the central bank of china in the rmb exchange rate. under china’s special conditions,the spot exchange rate’s fluctuation is the government’s goal. in this case,the central bank’s intervention is efficient,but the costs involved are still increasing as the exchange rate regime reform moves forward. © universiti putra malaysia press.