Since China's entry into the World Trade Organization and its gradual move towards capital convertibility,the link between the nation's exchange rate and domestic interest rates has become increasingly important. More than a decade ago,Professor Song Guoqing from Peking University asserted that the exchange rate was the key issue because it impeded the effectiveness of monetary policy. It suggested that the distortions of the exchange rate distorted interest rates. The assertion reflects the policy choices under the framework of the so-called "impossible trinity" - namely independent monetary policy,the free flow of capital and a fixed exchange rate. China opened the current account in 1996 and in recent years there has been a gradual move toward greater capital account convertibility. It is becoming more and more difficult to control cross-border capital flows. In theory,a country finds it difficult to manage flexibility in the exchange rate and maintain an independent monetary policy. Therefore,a question that remains to be answered is whether the exchange rate should be the focus or interest rates? What have China's authorities said about these policy choices in more recent years and what are the pros and cons of their approaches? Most importantly,what conclusions can we draw from the debate?

It is not difficult to see that 2014 was the point when there was a shift from heavy capital inflows to heavy outflows.

There were relatively strong expectations of renminbi appreciation between 2003 and 2013 with a relatively heavy upward pressure on the currency from capital inflows. From 2014 on,however,there have been relatively strong expectations of renminbi depreciation and pressure from capital outflows.

Pressure from Capital Inflows