The aim of renminbi exchange rate reforms is to make supply and demand the determining factor in the market. That goal came a little closer with the reform of August 2015,a move that also effectively devalued the currency and gave a bigger role to the market in setting the currency's central parity rate. Looking ahead we will need to give greater weight to supply and demand in our forecasts for the direction of the currency.

At present we tend to give greater weight to demand without fully appreciating supply. We also tend to understate the importance of capital and financial items in the international payments. This article tries to look at the effects on the exchange rate from cross-border capital flows related to China's bond market,while examining the impact of the currency's inclusion in the International Monetary Fund's Special Drawing Rights,a basket of global reserve assets. It also examines the potential for a full opening of the domestic bond market to foreign participation.

Capital Inflows

The internationalization of the renminbi and the opening of the Chinese bond market may play a decisive role in capital flows. From 1990 to 2010,capital controls kept international capital from entering the domestic bond market. In the 1990s,the Chinese financial market was just gaining traction and decision makers chose the restrict inflows because they were uncertain of the impact of large amounts of capital. From 2003 to 2010,authorities chose to make a very gradual opening of the capital market,careful to avoid attracting more speculative funds. After 2010,the regulators felt more confident in permitting inflows of speculative capital along with the internationalization of the renminbi and the increasing convertibility of the capital account. The gradual opening took advantage of the expansion in global liquidity after the financial crisis and it presumed that foreign investors would want to enhance their holdings of financial assets as the Chinese economy powered ahead. Since then,foreign investors have steadily increased their holdings of renminbi assets. In early 2013,inflows of international capital to the bond markets of emerging economies in Asia - with the exception of China - slowed somewhat. China's attraction for foreign capital was clearly linked to the internationalization of the renminbi and the opening of the domestic bond market.