China’s exchange rate volatility and repression: the contradictory development of RMB Internationalization

Abstract

As the world's largest exporter and second-largest importer, China has made exchange rate stability as a top priority for its economic growth. With the development of decade years, nevertheless, China already holds excess dollar reserves that have suffered a huge paper loss because of quantitative easing in the United States. In this reality, China has been provoked into speeding RMB internationalization as a strategy to reduce the cost and get rid of the excessive dependence on the US dollars. Thus, the present study attempts to explore the leverage and asymmetry effect of China's onshore exchange rate (CNY), China's offshore exchange rate (CNH), China's foreign exchange reserves (FER), and RMB internationalization level (RGI) from Aug 2010 to Jan 2021, by examining the ARMA-GJR-GARCH model. Secondly, the paper divided the four- variables into two sub-periods based on the "8. 1 1" China's exchange rate reform in 2015, and then investigates the volatility contagion effect and dynamic correlation via Diagonal BEKK GARCH models, compare the difference within two periods. Thirdly, this study performs the four-series forecast in both univariate and multivariate GARCH frameworks. We observe that there is asymmetry, but leverage effect not present among four assets. CNY is more sensitive to good news than bad news, while CNH, FER, and RGI are more sensitive to bad news than good news. The results evidence that before Aug 2015, there is a weak contagion effect among them. But after Sep 2015, the model validates the presence of strengthen volatility contagion within CNY and CNH, CNY and RGI, CNH and RGI. However, the contagion effect is weakened between FER and CNY, FER and CNH, FER and RGI. Moreover, the results exhibit large GARCH effects and relatively low ARCH effects among all periods. Furthermore, this study shows that there is no causality between the volatility of CNY and the volatility of the FER, also not a causal relationship between the volatility of the CNH and the Volatility of the RGI. But exists a time-varying dynamie correlation among them and connected with specific events. Such, forecasting figures of four assets, and assets returns, and assets volatility over the next ten months would be beneficial for policymakers, dealers, investors, traders, and future researchers.