20 Years of Missed Opportunities in China’s Exchange Rate Policy

Executive summary

Twenty years ago, China broke its de facto peg of 8.276 RMB to the US dollar and started a process of reforming its exchange rate regime. This report reviews the most important moments in that process, what has changed in twenty years, and more remarkably, what has remained the same. The key findings include:

• Despite multiple pledges over several years to introduce more market influence to the currency, the PBOC has continued intervening in the foreign exchange market on a regular basis. There has been more volatility in the exchange rate’s movement over time but little change in the underlying regime.
• The limited movement of the currency over the past twenty years has generally prevented the PBOC from using the exchange rate as an instrument to drive macroeconomic adjustments in China’s economy.
• Even when offered favorable macroeconomic conditions to change the exchange rate regime, the central bank and political leadership treaded cautiously, and made minimal progress in reform.
• The loss of policy credibility over the past twenty years has been severe. If the PBOC announced that they were floating the currency in July 2005, most market participants would have believed them. If the central bank made that same announcement today, virtually no one would believe it, given the persistence of intervention in the foreign exchange market over a long period of time.
• The current period of US dollar weakness offers a new opportunity for China to introduce new exchange rate reforms, perhaps via the daily central fixing mechanism or additional steps toward capital account liberalization.

Fundamentally, the story of China’s exchange rate policy over the past twenty years is one of missed opportunities. These have been missed because of political compromises, policy missteps, and changing external conditions. But in July 2025, Chinese leaders are still facing many of the same problems in setting exchange rate policy that they faced in July 2005. Fixed exchange rate regimes are only as credible as the political commitment to them. China has never been fully committed to exchange rate stability, but has also never been interested in a completely market-determined currency either. As a result, markets have consistently speculated about the PBOC’s reaction function and how it will manage the currency, which has created significant swings in capital inflows and outflows over the past twenty years. Those capital flows have significantly influenced China’s monetary policy and the stability of its financial system, and even today, the potential for a surge of outflows remains a persistent threat to financial stability. Rather than greater exchange rate flexibility providing China with more options to manage domestic monetary conditions, the PBOC remains constrained by concerns about initiating capital flows.

China’s exchange rate policy reflects a conflict between China’s political culture and the “corners hypothesis” that either fully fixed or fully flexible exchange rates are less crisis-prone than intermediate regimes. While there has been extensive economic research on this question since the Asian financial crisis in particular, the argument for either fixed or floating regimes is typically that they are more credible, since any combination of economic variables could cause central banks or political authorities to consider a shift in the value of an exchange rate in an intermediate, “fixed but adjustable” regime.¹

From 2003 to 2005, China’s internal debate on exchange rate policy heavily influenced by the experience of the Asian financial crisis. During that crisis, capital outflows from several Asian export-led economies quickly broke “fixed but adjustable” exchange rate regimes, particularly in countries facing current account deficits because of pegs to the rising dollar. The lesson of the crisis for many economists was that fixed exchange rate regimes in particular were prone to policy instability. In 1999, then-Premier Zhu Rongji had earned international plaudits by keeping the RMB stable against the dollar to avoid further competitive currency devaluations that might have extended the crisis. By 2003, however, with Wen Jiabao as Premier, it was obvious that China’s external surpluses were rising and the domestic costs of maintaining a fixed exchange rate were growing as well. Those costs included the PBOC losing control of the money supply, importing inflation (and potentially deflation in the future), along with keeping China’s domestic economy highly imbalanced and dependent upon exports and investment, rather than domestic consumption.

Keeping the exchange rate fixed was a form of state-led industrial policy, privileging state-directed investment decisions by effectively influencing prices for tradable goods. Letting the exchange rate float would allow international markets to determine those prices, potentially impacting the profitability of businesses and the returns on both private and state-directed investments. Additional flexibility in China’s exchange rate thus became both an enabler and an indicator of China’s overall commitment to market-based economic reform. And it was publicly announced every day in global financial markets, forcing an official daily disclosure of China’s progress.

But the gradualist tendencies of China’s political system argued against radical change to the exchange rate regime in 2005, despite the advice of several economists to either commit fully to a fixed exchange rate system or let the currency move in line with market conditions. The net result of the 2005 exchange rate reforms was what one PBOC adviser labeled an “A plus B divided by two” policy, in which China ended its de facto peg to the US dollar on July 21 of that year but made only a limited 2.1% adjustment in the exchange rate, while managing the pace of appreciation carefully.

This compromise meant that markets could easily see the likely path to further appreciation, and that the PBOC was no longer committed to its fixed exchange rate regime: The result was rapid capital inflows and continued growth of bank deposits and the money supply. At the same time, the limited adjustment to the level of the exchange rate meant that China’s trade imbalances did not adjust, and only increased. This brought more money into China’s banking system, while also sparking significant international pushback against China’s rising trade imbalances. The current account surplus reached almost 10% of China’s GDP in 2007. Even as the currency appreciated and new hedging tools were introduced in onshore markets, China had missed a significant opportunity to attempt to restructure its growth model and reduce domestic and external imbalances.

Those same gradualist tendencies in Chinese policymaking persist today, as Beijing continues to manage the trade-offs between the level of the exchange rate, the level of external imbalances, and capital flows. The current debate over China’s exchange rate policy in 2025 focuses heavily upon the same types of questions as in 2005: How will the PBOC balance the domestic economy’s need for lower interest rates with the corresponding pressure on capital outflows? How should the PBOC intervene in the currency markets in order to discourage self-fulfilling capital outflows, and what level of exchange rate volatility is helpful in this objective? How can China balance domestic policy needs to combat deflation (implying a need for a weaker currency) with international political pressure to reduce China’s trade imbalances?

This particular story has personal significance to me as I wrote my doctoral dissertation on the forces that produced the 2005 exchange rate reforms, and the consequences of the resulting compromise. At the time, China was in the midst of significant financial reforms following the Asian financial crisis. I had arrived in China to live for the first time in 2001, before the country had joined the World Trade Organization. Capital controls limited conversions of foreign exchange in both directions. Informal money brokers inside newsstands in Beijing were a reality, and black market exchange rates were published on websites. Hedging tools for exporters and foreign investors to manage their foreign exchange risk were nonexistent, in part because there was no currency risk with the exchange rate pegged to the dollar.

With the 2005 reforms, the PBOC led by Governor Zhou Xiaochuan generally believed that China was moving toward a floating currency over time, and that the political barriers to further exchange rate volatility would gradually break down. In the context of accelerating financial reforms at the time, this belief was reasonable. I spoke to several academics and financial technocrats who genuinely viewed exchange rate reform as a catalyst for further market determination of prices, and a way to kickstart China’s domestic consumption growth as well, while giving the PBOC more control over domestic monetary policy. These officials resented foreign pressure on the exchange rate but also saw it as somewhat useful as an argument they could use internally to advance their objectives.

It is in the context of these ambitions among China’s financial technocrats in 2005 that this note argues that the past twenty years represent multiple missed opportunities for deeper reforms. Twenty years later, China has less freedom to set its exchange rate than before, because of concerns about persistent and self-fulfilling capital outflows. The exchange rate was never used as a meaningful policy tool to drive adjustment of China’s internal or external imbalances. Sequencing of financial reforms between exchange rate reform, interest rate liberalization, and capital account opening was never a priority, allowing the PBOC to make incremental progress on all three fronts but limiting advancement in market determination of the exchange rate or the cost of capital overall. Faster reform simply clashed with the need to maintain perceived stability within China’s financial system.

Moreover, these were domestic policy choices—foreign pressure had, at most, a peripheral influence on policy. Before the 2005 reforms, Chinese policymakers were heavily influenced by the technical advice from the International Monetary Fund and the prevailing international consensus of economists that fixed exchange rate regimes were prone to instability, but they were not particularly worried about the United States calling China a “currency manipulator.” Mark Sobel of the US Treasury, who was perhaps the most influential US official engaging with China on the exchange rate from 2003 to 2016, has authored a definitive account of that period from Treasury’s perspective, focused on the need to align China’s domestic priorities with US interests.² Should China have been designated as a manipulator, there was a legitimate concern that the PBOC would simply be weakened internally, which might set back progress toward further reform.

This account of the past twenty years of China’s exchange rate policy attempts to evaluate Beijing’s decisions and the PBOC’s management of the currency on the basis of China’s objectives at the time. Individual moments and turning points in exchange rate policy are highlighted here, and certainly some important parts of the story have been left out for brevity’s sake. But the story reveals how initial reform objectives were eventually discarded, and how policy mistakes started to constrain the PBOC’s choices in managing appreciation pressures for the first decade, and then depreciation pressures for the following decade. Despite these missteps, China still had options to improve the credibility of its exchange rate regime at several important intervals, but chose not to take those opportunities. The concluding sections discuss what may come next in China’s exchange rate management, including some hints provided by PBOC Governor Pan Gongsheng and longtime SAFE official Guan Tao, and the lessons for markets from China’s experience.

Persistent intervention over time

The chart below highlights how China’s intervention into the foreign exchange market has been persistent, despite many PBOC pledges to withdraw from regular management of the currency. It also reveals how China’s exchange rate management changes quite rapidly from month to month, revealing policy changes.

The proxy for PBOC intervention that we used is based on the difference between the movements of USDCNY spot market prices with the movements of other major currency pairs. The difference is highlighted in the “intervention proxy” or the purple line. The hypothesis driving the proxy is that in general, if the currency is market-determined, the RMB will move with roughly the same volatility of other currency pairs against the dollar. Therefore, if the difference between the volatility of the RMB and other market-determined major currencies is close to zero, market forces are likely playing a greater role in driving the currency’s movement. If the difference remains persistently positive, or above zero, for an extended period, it likely indicates some level of PBOC intervention.

As Figure 1 reveals, the blue line for USDCNY movements is considerably less volatile than the movements of other currency pairs, probably indicating some level of intervention. The chart also shows how intervention behavior by the PBOC can change quickly, such as the periods of rapid depreciation during the initial phases of the trade war in 2018 and in stronger intervention during the COVID-19 crisis in financial markets in 2020.

The long and winding road

The chart below reveals the long path that China’s exchange rate has taken from its pre-2005 level of 8.276 per dollar to a low of 6.04 per dollar in early 2014, before retreating to the 7.34 level during the height of the trade war in April 2025. Overall, China mostly faced persistent market pressures for appreciation of the currency in the first decade from 2005 to 2015, and then ongoing pressures for depreciation from 2015 to 2025.

As we have argued previously, we expect the combination of lower interest rates and persistent capital outflows to weaken China’s currency against the US dollar in the future, from its current level of around 7.18. We discuss the critical phases of China’s exchange rate management briefly, as well as the implications of these changes and where Chinese leaders missed opportunities to deepen reforms.

The 2005 reforms and their immediate aftermath

On July 21, 2005, at 7 pm, China’s central bank announced that the currency would immediately appreciate to 8.11 per dollar, a move of 2.1% from the previous de facto peg of 8.276. The PBOC announced that China was “moving to a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB will no longer be pegged to the US dollar and the RMB exchange rate regime will be improved with greater flexibility.”

The PBOC also announced that the exchange rate would adjust based on a daily central parity rate. The currency could move 0.3% against the dollar on either side of that daily central parity, which would be determined based on the previous day’s closing price. The daily trading band would gradually be expanded to 0.5% per day in May 2007, then to 1% in 2012, and eventually to the current level of 2% in 2014.

The critical issue for most observers, of course, was what would happen the next day, and in the weeks ahead. It was fine for the PBOC to talk about moving to a “managed floating” regime, but the currency needed to actually float to some extent. But as the chart above indicated, the currency barely moved at all for the rest of the year, closing the year at 8.07 per dollar. It only broke the level of 8.0 to the dollar in June 2006, taking almost a year after the initial move to appreciate only 1.3%.

The critical lesson from this initial period was that even though the exchange rate regime was now labeled as a “managed floating” regime, the currency continued to trade only within a very narrow band, and the PBOC was clearly continuing to intervene on a daily basis to manage the currency’s appreciation. Because the initial appreciation was so limited, markets and investors could clearly anticipate that the currency would continue rising against the dollar, given China’s persistent current account and capital account surpluses. Capital inflows to China surged, often to move into the property market and the stock market. The appreciation was not nearly sufficient to influence the competitiveness of China’s exports, and the trade surplus continued surging as well, rising from $102 billion in 2005 to $261 billion in 2007.

Implications:

• The PBOC continued intervening in foreign exchange markets despite the reported change in the exchange rate regime, but now had less credibility to defend any particular level of the exchange rate.
• Capital inflows increased anticipating further currency appreciation.
• Trade flows barely responded to the shift in exchange rate policy, and the trade surplus surged.
• Short-term political compromises rather than long-term technocratic plans drove the 2005 exchange rate reforms.

Missed opportunities:

• The PBOC could have allowed more movement in the exchange rate initially to show that the regime had changed, which would have relieved some political pressure.
• The PBOC’s moves only entrenched expectations of one-way moves in the currency, given the limited initial appreciation.
• The PBOC weakened the credibility of its commitment to currency stability over time, as it had just adjusted the exchange rate without signaling a commitment to a new level.

The 2007 Strategic Economic Dialogue and faster appreciation

Discussions between China and the United States concerning China’s exchange rate policies had occurred throughout the period from 2003 to China’s eventual exchange rate reforms in July 2005. But the slow pace of RMB appreciation and the rise in Chinese imports to the United States, along with continued job losses in US manufacturing sectors rekindled political pressure on China to allow the currency to move faster from both the Bush administration and Congress. In 2006, Treasury Secretary Henry Paulson announced the creation of a new Strategic Economic Dialogue (SED) with China, which was designed to elevate US concerns about China’s economic policies across the entirety of the Chinese government.

While the first session of the SED was held in Beijing in late 2006, the May 2007 session in Washington marked an interesting transition in both China’s exchange rate management and US frustration with Beijing’s resistance to faster movement and the rise in bilateral trade imbalances. Starting in May, the pace of appreciation accelerated significantly from a 2.4% appreciation against the dollar in the first half of 2007 to a 3.9% appreciation in the second half (relative to the end-2006 level). China was both raising interest rates to combat inflation and using quotas on loans to prevent inflows from triggering excessive investment. China’s primary stock market index, the Shanghai Composite, reached an all-time high in October 2007. The pace of currency strength continued with a further 4.1% appreciation in Q1 2008. This was the fastest period of RMB appreciation since exchange rate reform, bringing the currency to around 6.83 per dollar by July 2008, a full 17.5% appreciation from the original pre-July 2005 level.

During this time, China also started to conceal the pace of its foreign exchange reserve growth. They did this first with artificial requirements forcing banks to purchase dollars to pay for adjustments in banks’ reserve requirements, and then labeling the reserves as “other foreign assets” on the PBOC’s balance sheet, rather than formal reserve holdings. In addition, when the China Investment Corporation was created in 2007 and financed originally through the transfer of $200 billion in foreign exchange reserves (or more depending upon the exchange rate used), the timing of these transfers on China’s official foreign exchange reserve levels was never clarified. By June 2008, China had officially added $742 billion to its reserves since the end of 2006, but had likely concealed around $300 to 400 billion more.

Implications: China seemed to react to both domestic inflation and international political pressure in guiding exchange rate movement. This raised the significance of currency negotiations with the United States in ongoing market calculations of the PBOC’s reaction function in guiding the exchange rate.

Missed opportunity: The period of faster appreciation and faster reserve accumulation gave Beijing an opportunity to become more transparent about the operations of its intervention and data concerning its FX reserve accumulation, when China was accumulating significant quantities of reserves. This set in motion a pattern in which there was persistent market uncertainty about how much China was actually intervening in the foreign exchange market, both to limit appreciation and eventually depreciation.

The global financial crisis and mistakes in signaling depreciation

As the global financial crisis materialized in the fall of 2008, China essentially stabilized its exchange rate as the dollar surged and exports fell. The currency remained within a very narrow range of 6.80 to 6.87 per dollar from July 2008 to June 2010. But in the depths of the financial crisis, after China had reported some abysmal economic data, launched a new stimulus plan, and cut interest rates by the largest margin since 1993 (108 basis points in late November), the PBOC started flirting with the idea of depreciating the currency as well.

On December 1, 2008, the currency’s daily central parity was set significantly outside of its previous range, at 6.8505 from the previous trading day’s 6.8349. While the move was only around 0.23%, it was the sharpest adjustment in the daily central parity since the most intense period of the global financial crisis in September. The coincidence with the weaker economic data signaled to the market that the PBOC was potentially attempting to guide the currency weaker to help China to offset some of the impact of the crisis. The PBOC’s moves were mentioned publicly during the session of the US-China SED held the following week, with the central bank forced to clarify that they did not intend to create a policy-led depreciation. But the move in the central parity did occur, and the concerns in the market that the PBOC continued to manage the currency for policy reasons persisted.

Implications: China was perceived as willing to float the idea of depreciating the currency as a policy instrument to offset the impact of the global financial crisis, marking a change from Zhu Rongji’s approach in stabilizing the currency during the Asian financial crisis in 1999.

Missed opportunity: The PBOC could have clarified how the central parity was set, and introduced additional market influence into that process, to respond to legitimate concerns that it was solely a reflection of policy intentions.

June 2010 and another break of the peg

By June 2010, China had started a significant credit expansion for eighteen months and a clear recovery from the effects of the global financial crisis was underway. However, the currency had remained pegged to the US dollar once again, for reasons that were increasingly difficult for the PBOC to defend publicly. After all, nothing had changed since the 2005 exchange rate reforms except for the perceptions of external financial risks. But as the dollar depreciated, with the RMB along with it, and the euro strengthened above 1.50 in November 2009, the PBOC did not appear to be managing the currency with reference to any trade-weighted basket or considerations.

After some rounds of diplomacy on the issue with the United States, the PBOC announced on June 19, a Saturday afternoon, that they would resume allowing some additional exchange rate flexibility, consistent with the stabilization of China’s economy. The PBOC statement read, “management and adjustments of the exchange rate must be carried out gradually to give companies time to adjust their structure and gradually absorb the impacts of yuan exchange rate fluctuations.” The currency’s daily central parity was set identically to the previous Friday’s rate, but within the trading day, the currency moved around 0.5% against the dollar, resulting in a stronger daily central parity by 0.43% on the following day, before gradually resuming an appreciation path.

Implications: The late adjustment following the global financial crisis only reinforced global perceptions that politics and economic policy concerns, rather than markets, were driving China’s exchange rate policy.

Missed opportunity: China could have allowed more exchange rate flexibility in 2009 and early 2010 to reinforce the credibility of exchange rate reform at the time, and to emphasize that China had emerged from the effects of the global financial crisis quickly.

The European debt crisis in 2011 and the CNY-CNH spread

In late 2011, with the European debt crisis intensifying and European banks consequently curtailing USD lending to the region, China’s foreign exchange markets saw a new development, with the offshore CNH starting to trade at a significant discount to the onshore CNY, approaching 2% in September of that year. The pools of offshore CNH had been rising in Hong Kong throughout 2011 in anticipation that the currency would continue appreciating. Now with many Chinese banks in Hong Kong seeing tightening US dollar funding availability, the offshore CNH was weakening, offering an opportunity for anyone who could arbitrage the two rates by buying the offshore RMB in Hong Kong and selling it onshore in China, either through direct transfers or through a mirrored transaction. The spread between the offshore and onshore rates gradually narrowed in late 2011 and early 2012 as funding conditions for European banks stabilized.

Implications: China’s exchange rate onshore was pressured for the first time by developments created by the offshore CNH market, introducing new risks from RMB internationalization to onshore currency stability.

Missed opportunity: The PBOC could have clarified how they would intervene in future situations when the offshore and onshore spot rates diverged, reinforcing the credibility of the offshore market and avoiding some of the blunt moves that were eventually taken in 2015.

2012-2013 and interesting transitions in currency management

In the spring of 2012, the Chinese economy weakened and the currency started a period of limited depreciation against the US dollar, declining to 6.3967 per dollar at the end of July from 6.2948 at the end of 2011. Yet reserve growth continued during this period and capital inflows were particularly strong, in part because of an ongoing carry trade in which Chinese assets fetched much higher interest rates than corresponding US assets still emerging from the global financial crisis.

The interesting behavior in the PBOC’s currency management occurred at the end of 2012, when PBOC Governor Zhou Xiaochuan was still in office but widely expected to retire, until he was reappointed in early 2013. While Zhou made some well-publicized remarks promising further capital account liberalization, and then clarifying that he still intended to maintain some level of capital controls, the PBOC seemed to change their regular intervention patterns in the foreign exchange market in November and December.³

Capital inflows had resumed after a period of limited depreciation and weaker growth. Rather than intervene to buy US dollars as was typical, the PBOC seemed to slow intervention on a daily basis, and forced foreign exchange market participants to settle with the central bank through third currencies rather than the US dollar. Foreign exchange settlement through banks surged to an implied inflow of $18.5 billion in November 2012 and $53.4 billion in December, but official FX reserves only rose by $24.2 billion during those two months combined. This strange practice quickly forced the exchange rates of those currencies to the edges of their trading bands, and introduced unusual market distortions. The practice was quickly abandoned, and then the PBOC simply resumed buying dollars in mid-December. By January, official FX reserve growth surged by $98 billion for the month alone.

Mark Sobel, the Deputy Assistant Secretary for international monetary and financial policy at the US Treasury at the time, labels this period of time as highly contentious, with China resisting further exchange rate appreciation despite significant reserve accumulation.² From the second break of China’s de facto exchange rate peg in June 2010 to the end of 2013, China’s official reserves surged by an astonishing $1.37 trillion. It is probable that this period kickstarted the PBOC’s efforts to start concealing their regular intervention into the foreign exchange market.

Implications: The PBOC once again resorted to a degree of subterfuge in trying to conceal their levels of intervention, unsuccessfully. Dollar purchases were extremely strong given the persistence of current and capital account surpluses and clear PBOC currency guidance toward additional appreciation.

Missed opportunity: The PBOC could have allowed more flexibility to discourage one-way bets on the currency and the resulting leveraged carry trades. The delay essentially forced Zhou Xiaochuan to react in 2014.

Zhou breaks the carry trade, sparking capital outflows

By early 2014, the carry trade betting on appreciation of China’s currency had grown significantly, and both Chinese and offshore corporates were buying leveraged products that multiplied returns as long as China’s currency remained relatively stable and continued its steady crawl upward against the US dollar. It was around this time that China’s currency hit its all-time high of 6.04 per dollar.

But that would not last long. Zhou Xiaochuan launched an attack against the carry traders in late February 2014, setting the daily central parity higher, and driving artificial currency weakness and additional volatility. In intraday trading, the PBOC seemed to intervene on the other side of the foreign exchange market, buying dollars aggressively to actively weaken the RMB rather than simply managing the RMB’s appreciation.

The net result was the start of an aggressive period of currency hedging behavior by China’s corporates, including state-owned firms, who suddenly had to manage against the risk of a suddenly depreciating currency, and additional volatility in the currency. This sparked dollar demand to cover the costs of the leveraged products that state-owned and offshore corporates had purchased.

Implications:

• The PBOC indicated its willingness to respond to the profit-taking behavior of state-owned enterprises, and to discourage one-way bets on the currency’s movement. The state-owned sector benefited from low volatility, and the PBOC directly encouraged policy volatility, contrary to their interests.
• The PBOC had become concerned that they were basically subsidizing market bets on currency appreciation.

Missed opportunities: The central bank could have moved to rekindle two-way volatility in the currency after this move, which would have reduced the shock of the 2015 policy changes that followed.

The August 2015 depreciation opens Pandora’s box

One of the most dramatic changes in China’s exchange rate policy over the past two decades occurred on the morning of August 11, 2015, after two months of media frenzy over China’s attempts to bail out its flagging stock market. During the morning, the daily central parity was set 1.9% weaker, in a poorly designed attempt to unify the spot and the fixing rates in order to eliminate the basis risk in the currency’s pricing, so that the RMB could more easily pass reviews for admission into the IMF’s Strategic Drawing Right (SDR) currency basket.

The move on the morning of August 11 touched off a broader market panic, as it appeared that China was attempting to depreciate the currency as a policy objective, as the economy was weakening and Beijing had struggled to support the equity market. The immediate questions that emerged in the market concerned how fast the currency might weaken, sparking rapid capital outflows, a huge gap between the onshore CNY and the offshore CNH, and rapid hedging activity by Chinese corporates to purchase dollars. The PBOC scrambled to contain the damage, ending the near-term currency shock in just three days with a press conference on the morning of August 13 held by Deputy Governor Yi Gang, but catalyzing longer-term pressures on the currency.

The net result was that China suddenly faced a significant balance of payments crisis caused by expectations of continued depreciation, and through the 18 months following the August 11 depreciation, the PBOC spent over $1 trillion in reserves defending its currency. In mid-September 2015, the PBOC may have spent tens of billions of dollars in reserves simply attempting to close the gap between the offshore CNH and the onshore CNY. The move also ended the market perception that the currency was on a long-term appreciation trend, as now the risks of longer-term depreciation were far more apparent. Even after the currency joined the IMF’s SDR basket in November 2015, the long-term trend toward capital outflows persisted. The shock depreciation had changed market perceptions of the PBOC’s policy credibility, and commitment to the stability of the currency.

Implications:

• PBOC had lost significant policy credibility after the stock market bailout. The timing suggested that the central bank might weaken the currency as a matter of policy to offset domestic financial and economic pressures.
• SDR inclusion would not be a panacea for China’s need for inflows, given continued economic policy missteps in other areas.
• Closing the gap between the onshore and offshore currency prices was a significant priority for the PBOC.

Missed opportunities:

• The PBOC’s messaging around the August 11 moves only confused market participants, and the timing was likely not decided by the PBOC itself. Clearer messaging could have reinforced the reform-focused nature of the moves to eliminate the basis risk between the spot rate and the central parity rate. Instead the messaging only catalyzed more capital outflows.
• China could have persisted with the reforms as well to allow some depreciation quickly, which would have eliminated the basis risk between the spot rate and the fixing rate, and reduced long-term pressures for capital outflows, given that some outflows at the time were inevitable. Instead, the move only catalyzed further outflows from RMB-denominated assets.

Squeezing the offshore CNH market in 2016 and 2017

As market pressures on the currency built in late 2015 and early 2016, the PBOC started to use one of its most aggressive options to defend the currency, by squeezing liquidity in the offshore CNH market, making it more difficult to borrow the currency and buy US dollars. This reflected a tradeoff between the immediate need to weaken capital outflows and the longer-term objective to promote the internationalization of the RMB.

Unsurprisingly, short-term currency stability was viewed as far more important to the PBOC, even if it meant shocking the offshore funding markets with opaque policy-driven interventions in January 2016 and January 2017. These measures were temporarily effective at reducing capital outflows and the offshore-onshore arbitrage flows, but at the expense of longer-term usage of the currency offshore. Unlike the Federal Reserve’s actions when facing tightening conditions for US dollar liquidity around the world, the PBOC chose to withhold liquidity in its own currency rather than offering more.

Implications: RMB internationalization was always a second-tier objective for the PBOC when the exchange rate came under pressure.

Missed opportunity: The central bank could have continued squeezing the offshore market and chosen to instead liberalize the capital account more aggressively in response, reducing the need for separate onshore and offshore currency markets.

The first trade war, with the currency offsetting tariff pressures

In 2018 and 2019, China faced the concerted threat of US tariffs from the Trump administration for the first time, and chose to use the currency to offset some of the economic impact of this pressure. The PBOC kept the currency stable in the early rounds of negotiations with the United States in April and May, likely in order to avoid provoking a harsher response. But once trade negotiations broke down, the central bank started weakening the currency, first in a catchup move against the US dollar and then seeing depreciation extend from 6.27 in early April to above 6.93 in early August 2018.

As rounds of tariffs intensified, China would generally allow the currency to depreciate in response to market pressures that were strengthening the dollar, establishing some resistance around critical levels of the currency such as 7.0 per dollar, but generally allowing more movement. When trade tensions appeared to be moderating, China would then allow greater appreciation and some actual volatility.

Perhaps the most effective use of PBOC market communication occurred in August 2019 when the currency finally moved back through the 7.0 level against the dollar, which the PBOC described as a result of market pressures caused by the imposition of another round of US tariffs on Chinese imports. As a result, there was no dramatic surge in capital outflows or depreciation pressures after the currency weakened through 7.0 and eventually to as high as 7.1854 in September 2019.

Overall, the PBOC allowed roughly a 14% depreciation of the currency against the dollar during the first round of trade conflict with the United States, meaningfully reducing some of the economic pressures that had resulted from the tariffs themselves.

Implications: China was willing to use the currency as a policy tool in the context of trade conflict, introducing new reasons for markets to anticipate the PBOC’s policy reaction to managing the currency under changing economic conditions.

Missed opportunities: The PBOC’s management of the currency around critical levels only reinforced market perceptions that the currency was a policy tool for the central bank, and that intervention was persistent. In addition, external political considerations clearly overwhelmed domestic economic concerns in driving the currency’s movement.

COVID-19 and new reform possibilities

After the first rounds of market panic from the rapid spread of COVID-19, China’s policy response to the pandemic in early 2020, with strict lockdowns early and heavy restrictions on international travel, created surprisingly favorable conditions for the RMB and China’s international balance of payments. While developed market central banks including the Federal Reserve rapidly cut rates toward zero levels, China cut rates in early 2020 but then held them, creating much higher interest rates in China than in the rest of the world. In turn, this helped to encourage portfolio inflows, with the spread between US and Chinese 10-year bonds peaking at levels over 240 bps. Capital outflows were controlled by the limited opportunities for travel among Chinese citizens during the pandemic and strict quarantine rules. The near-term pressures for the currency to weaken had disappeared, while China’s trade surpluses surged amid global demand for goods rather than services, creating opportunities for further appreciation.

If there was ever a timeframe in which China could have meaningfully reduced its intervention into the foreign exchange market and created a market-driven currency, this was it. The currency may have appreciated slightly in response to such an announcement from the PBOC, but inflows would have still been limited by the general global risk aversion during the pandemic itself. China could have actually introduced far more flexibility in the exchange rate regime, discarded the daily central parity and the daily trading band, and would have probably seen no significant short-term market reaction, nor a surge in capital outflows. Capital controls were already being effectively tightened by the pandemic restrictions themselves.

Instead, China continued to intervene in currency markets in 2020 and 2021, but now concealed that intervention through activities by state banks, both onshore and offshore. Lending by Chinese banks to their offshore subsidiaries surged, allowing the offshore banks to buy the USD-denominated assets that the central bank would have otherwise purchased. Rather than moving toward more transparency in exchange rate policy, the PBOC was creating new forms of hidden transactions.

Implications: Intervention was likely to continue indefinitely, given that the PBOC continued to limit appreciation even when they would not have been severely impacted by changes in exchange rate policy.

Missed opportunity:

• China could have used pandemic conditions to finally move toward greater exchange rate flexibility with minimal economic consequences, but chose not to do so.
• Intervention activity through state banks became far more common, reducing the transparency of China’s activities in its foreign exchange market.

Russia’s war and the Federal Reserve hiking rates

Two developments in early 2022 sparked a dramatic shift in China’s balance of payments conditions, and created stronger depreciation pressures on the RMB than at any point since the 2015 balance of payments crisis. The first event was Russia’s invasion of Ukraine and the perception of China’s alignment with Russia, which introduced new perceptions of political risks in investing in Chinese assets, reducing inflows. The second and perhaps more significant development was the Federal Reserve’s persistent hikes in interest rates, which reversed the benefit that Chinese assets had held over US dollar rates over the previous fifteen years. Given that safe Treasuries were now yielding 4 to 5%, investors needed new and compelling reasons to hold Chinese assets. On top of this, zero-COVID policies in China in 2022 were dramatically impacting China’s economic growth and reducing global perceptions of China’s policy credibility.

The net result of these changes was a significant shift in capital flows in China’s balance of international payments from inflows to outflows, very quickly. As China’s own outlook deteriorated, both under COVID-19 restrictions and after the pandemic, capital outflows intensified as Chinese investors able to travel again started accumulating US dollar assets. The currency hit the lowest levels seen since 2007, breaking the 7.30 per dollar level in late October 2022.

In response, the PBOC started engaging in new forms of intervention to stabilize the currency, intervening via the forward markets, and forcing commercial banks to sell dollars in the spot market to hedge against these forward positions with the PBOC. The net result of this intervention was a form of subsidy to anyone who was willing to lend dollars to the PBOC and hold RMB-denominated assets for a limited period of time, while hedging their currency risks in doing so. The PBOC was essentially paying foreign hedge funds and Chinese exporters a few billion dollars per year to borrow their dollars to sell, rather than reveal its own level of intervention.

Implication: Given the change in the interest rate spread between the US and China, capital outflows from China were likely to persist for many years given the pressure on China’s economic outlook and the expected path of interest rates.

Missed opportunity: China could have revealed the extent of its forward intervention via state banks from previous years, which would have reduced market speculation about the possibility of rapid depreciation in the future.

2025 and the new trade war

As 2025 began and China started to assess the potential for a new trade war with the second Trump administration, market attention turned to the prospect for currency depreciation in response to additional tariffs, repeating China’s playbook from 2018 and 2019. But the Trump administration’s overreach on April 2, with “reciprocal” tariff rates assigned based solely on a country’s trade deficit with the United States, the US dollar weakened significantly, reducing pressure on China’s currency. As the reciprocal tariffs were delayed, at first for 90 days, the dollar weakness extended and China and the United States engaged in two rounds of discussions about bilateral tariffs and other export restrictions such as those on rare earth minerals and magnets. The RMB barely started appreciating against the dollar in early July, but ticked up only to 7.15. The Chinese currency has still weakened against the euro by around 11% in 2025, with more Chinese exports now shifting to Europe rather than the United States.

As a result, China again finds itself with a new round of opportunity to reform its exchange rate regime. Changes that are implemented under current conditions would probably be received favorably, and could catalyze limited capital inflows into Chinese markets. Additional capital account liberalization could help to restore market confidence that was lost under the crackdowns on Internet and technology firms in 2021 and zero-COVID policies in 2022. Additional transparency in the setting of the daily central parity could reduce market perceptions of policy-driven interventions in exchange rate policy. But as this story has revealed, any hope for dramatic change should be limited, as China has missed multiple similar opportunities to reform its exchange rate regime over the past twenty years.

What could be next?

Anniversaries matter in China’s policymaking process, as they provide an opportunity to assess changes in policy and rekindle reform efforts. The change in China’s exchange rate policy in August 2015 was close to the 10-year anniversary of reform. With the 20-year anniversary, the question becomes what the PBOC might do to reinvigorate reform efforts. China has an opportunity to make policy changes without sparking dramatic capital outflows, given the weakening US dollar and US policy missteps that have reignited global interest in capital inflows into China.

One of the most probable steps we could envision would be some new effort at capital account liberalization in order to encourage more international investors to hold RMB-denominated assets. PBOC Governor Pan Gongsheng gave an extensive speech at the Lujiazui conference in June that discussed changes in the international monetary system and the RMB’s rise as a cross-border payments currency. This may suggest there could be efforts to expand those channels and promote additional capital outflows from China, which may be helpful in the current environment in which the PBOC is still limiting the level of appreciation of the currency.

Former SAFE official Guan Tao also published an article recently hinting at the possibility of changing the RMB’s daily central fixing mechanism, arguing that the rise in cross-border and offshore currency settlements for the RMB was creating a more persistent gap between the spot rate of the currency and the daily central parity rate.⁴ Guan seemed to suggest that a reform to the setting of the daily central parity rate, making it more in line with market conditions, would be beneficial for further capital account opening. He stated, “The domestic exchange rate continues to deviate significantly from the central parity rate, which not only affects macroeconomic analysis and corporate accounting, but also affects the exchange rate risk management of market entities … Improving the market-oriented formation mechanism of the RMB exchange rate will provide institutional guarantees for expanding capital account opening.”⁵ Ironically any such reforms to the fixing mechanism following this model would leave China basically back to where they started before July 2005, with the daily fixing determined by the previous day’s close.

There may be hopes for more dramatic changes in exchange rate policy as well. But after twenty years of promising reforms with only incremental adjustments, markets and observers would need to see a significant change in how the currency actually traded to suggest that any meaningful shift was underway.

Lessons from 20 years of China’s exchange rate policy

What are the implications of 20 years of experience in China’s exchange rate management? There are some clear continuities in PBOC behavior—the persistence of intervention despite official denials of regular intervention—and some important takeaways to anticipate how exchange rate policy will evolve in the future.

First, the PBOC and Chinese leaders continue to demonstrate persistent distrust of market forces. This will likely mitigate against exchange rate flexibility in the future. Breaks in the exchange rate’s levels will therefore be forced rather than guided. The central bank continues to criticize “one-way bets” in the foreign exchange markets and the resulting capital inflows and outflows, presumably oblivious to the fact that the PBOC was itself creating the conditions for these bets, which were predictable consequences of the central bank’s currency management.

Second, the transparency of PBOC policy actions in currency management has deteriorated over time. Officially, the PBOC’s data reveals virtually no changes in headline foreign exchange reserves since 2017, despite several cycles of inflows, outflows, appreciation and depreciation since that time. State-owned banks have stepped in and are largely concealing PBOC intervention in the foreign exchange market, both in spot and forward markets. Balance of payments data are now understating China’s current account surplus, using non-transparent data sources on Chinese trade activity.⁶ Additional data disclosures have been made consistent with the IMF’s Special Data Dissemination Standard (SDDS), but even the Fund finds China’s level of disclosures in foreign exchange management inadequate.⁷ This lack of transparency makes it increasingly difficult for the PBOC to credibly communicate a change in its intervention posture in the marketplace. Market rumors and wire service reports remain the key channels of communication.

Third, China has never used the exchange rate as a tool to drive macroeconomic adjustments and rebalance the economy toward domestic consumption. This is a distinct disappointment relative to the PBOC’s expectations for reforms in 2005. Arguably the PBOC was moving in this direction in 2007 and 2008 during the period of faster appreciation, but saw significant setbacks in the period from 2009 to 2014. Even during 2007 and 2008, the trend of currency strength slowed and trade-weighted appreciation was more limited than moves against the US dollar. It is arguable how much exchange rate appreciation might have weakened the structural forces driving investment-led growth in China, but it was never tried.

Fourth, RMB internationalization was always a secondary goal to currency stability, and will likely remain so. When the currency came under pressure, China was willing to set aside its objectives to drive RMB internationalization and tighten liquidity conditions for the offshore currency. Even inclusion into the SDR was never very meaningful as a driver of inflows relative to China’s own economic policy choices, which introduced new risks for investors. This disregard of the internationalization of the RMB when balance of payments conditions became more adverse for Beijing impacted Hong Kong as well, where authorities had made significant investments in becoming an offshore hub for RMB trading.

Fifth, the PBOC still communicates with the market via a limited set of policy tools, primarily via the daily central parity. Changes in the daily fixing rate still represent significant changes in the PBOC’s management of the currency, to a greater extent than market forces. This is why the August 2015 exchange rate move had such a significant effect on capital outflows, because it signaled a much broader policy shift. The central parity is still a problematic policy tool as well, as spreads between the central parity and market spot prices occur frequently. The PBOC’s other policy tools include adjustments of required reserve ratios for foreign exchange deposits, arbitrary adjustments in the “counter-cyclical factor” in the daily central parity, window guidance to banks and occasional warnings to the market to avoid one-way speculation. There are signs of long-term improvements in communication, with the PBOC using statements surrounding key events such as the break of the 7.0 level to the dollar in 2019, but these remain limited in light of the persistent opacity of PBOC objectives and the potential for rapid policy shifts.

Sixth, the PBOC has lost significant policy credibility over the past two decades. Since 2004, the PBOC has used the same wording to describe its objectives in exchange rate policy, arguing the currency will remain “basically stable at a reasonable and balanced level.” But within that rhetoric, actual policy has changed considerably. The persistence of intervention via state banks raises questions about how the central bank can communicate changes. Should the PBOC announce tomorrow that the exchange rate regime has changed entirely and will now be a free-floating regime for the first time, it seems unlikely that this would cause much of a stir in markets. After all, the PBOC has described their regime as a “managed floating” regime since 2005. The proof of the free float would be via market movements, not the PBOC’s statements, suggesting a distinct loss of central bank credibility.

Seventh and finally, exchange rate management is now hostage to the management of domestic debt. The rising economic pressure from domestic debt burdens means that Chinese interest rates are almost certain to move lower, and even zero interest rates in China are a topic of discussion at present.⁸ US rates will consequently remain above Chinese rates for the foreseeable future, producing incentives for capital outflows. This means that China’s long-term struggle against capital outflows is just starting, and the PBOC will need to decide when they will continue intervening to support the currency, and when they will allow more currency depreciation. On balance, the long-term decline in China’s interest rates and the emergence of quantitative easing by the central bank suggests the currency is more likely to weaken than strengthen against the dollar in the years ahead, but as always with China’s exchange rate policy, nothing is guaranteed.