Essay 2: Is The Chinese Renminbi Undervalued?
Since July 2005, first time being revalued after 11 years of fixing at 8.27, Chinese Yuan has been heading towards only one direction – all the way from 8.27 to 6.27. Although Yuan is a highly regulated currency by government, Chinese officials could no longer peg the Yuan as it used to be in a closed economy because WTO had opened up doors for Chinese manufacturers in 2001 to export cheap goods and services to developed countries. With trillions of foreign capital flooding into the country, Yuan has appreciated over 30% over seven years. However, this one-way money flow cannot be sustained. Though it is not sure ...view middle of the document...
On the other hand, it needs to hold huge foreign assets, primarily in USD, to back up its currency from deprecation in the event of capital outflows. Amid the money inflow, Chinese central bank faced mounting pressure of inflation on local assets. The private sectors are impacted in two ways. Firstly, Chinese residents and companies feel much richer now because higher RMB increases their purchase power of foreign assets. This means more imports and capital account outflows. Secondly, inflation and appreciation means that Chinese products and services are more expensive. And this would lead to less exports.
Pew Survey showed that 70% of Chinese people feel financially better off than five years ago, which among the best in the world. In the last a few years, the fact of continues Yuan appreciation, associated with stories about how China is cash rich and how Chinese investors are buying everything they can in the world, raises interesting discussion if Yuan had appreciated enough. There is also a trend that more goods are manufactured in new WTO members such as Nepal and Vietnam that have price advantage over China. Moreover, in the currency forward market, investors have priced in modest depreciation for Yuan in the next 12 months and spot market is no longer moving towards one direction.
All those various observations reveal the same process that drives RMB exchange rate to an equilibrium level. Recent data also suggests that at current FX level, the rise in trade surplus and capital & finance account surplus slowed (see chart below). So does foreign reserve.
Table 2: China’s Balance of Payments (Q3 2011 – Q3 2012)
Item | Q3 2011 | Q4 2011 | Q1 2012 | Q2 2012 | Q3 2012 |
I. Current Account | 534 | 605 | 235 | 537 | 708 |
A. Goods and Services | 650 | 554 | 38 | 687 |...