April 10, 2006
Prof. Kathryn Dominguez
Course Group Project
Effects of CNY Revaluation on Mongolian Economy
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Undervalued or not undervalued? This question regarding the Chinese currency (CNY) has been a center of heated argument among economists, experts, and investors for some period of time, yet it seems there is no clear answer to that. G-7 is pressuring the Chinese government to revaluate its currency, some saying keeping the currency undervalued will have a threatening effect on Chinese and world economy, especially on developing countries. Yet, again, Chinese government still has its currency pegged and it is not certain whether they will revaluate the currency by an appropriate amount, not even mentioning the possibility of adopting the managed floating regime. However, in this paper, we are taking the common notion of CNY being undervalued and we wanted to analyze what will be the effect of CNY revaluation, if Chinese government decides to do so, on economy of a developing country: its neighbor Mongolia.
Geographically, Mongolia is landlocked country located between China and Russia. Prior to 1990, Mongolian economy was centrally planned and highly dependent on Russia. Its major trade partner was, of course, Russia and other smaller players would include former Soviet Republics. In 1990, Mongolia has embarked on a transition to democracy and free market economy. During the time of transition, it had experienced hyperinflation, low economic growth, financial sector crisis, and other economic and social difficulties; yet, the country was able to recover from transition crisis in relatively short period of time and by the end of 1990’s, economy has been stabilized. As of the end of 2004, inflation rate was 11 percent and economic growth has reached to 10.6 percent, the highest since 1990. All the other macro economic indicators are looking up as well.
Furthermore, after the transition to free market economy, Mongolia has implemented open trade regime and floating exchange rate system, and expanded its foreign trade relations extensively and China has become the major trading partner. As shown in the Table 1, trade with China has been on steady growth, and as of 1999-2004, 33.6 percent of the total trade has been done with China; 47.4 percent of Mongolian export was to and 22.5 percent of import was from China.
Mongolian major export products to China are copper, gold, cashmere, and textile and clothing products. Copper and copper products accounted for about 40 percent of the total export in 2003; and as for the buyer, main importer of Mongolian products is China, whose main import products from Mongolia are copper and copper products, and raw and de-haired cashmere. Chinese imports weigh about 25 percent in total imports. Major goods from China are equipments, manufactured goods, agricultural goods, garments, and other consumer goods.
If the Chinese government were to revaluate their currency, CNY, then theoretically, Mongolians should see current account improvements as its export will be relatively cheaper. But, will it be really this simple and this good?
Is CNY Undervalued?
Chinese government has been claiming it has “adopted” managed floating exchange rate regime since 1994; however, it is evident that it has virtually fixed its exchange rate by
pegging it to the USD. (Figure 1) Accordingly, although recently most currencies continued to appreciate against weak USD, the CNY still moves around the targeted level, which causes other countries to believe that the CNY is undervalued relative to their currencies. Foreign exchange rates are determined by numerous economic factors: interest rate differentials, price differentials, inflation...