Harvard Business Case of International Finance , China to Float or Not to Float?
China: To Float or Not To Float?
International Finance
Executive Summary
On July 21, 2005, China revalued its decade-long quasi-fixed exchange rate of approximately 8.28 yuan per U.S. dollar by 2.1% to 8.11. Simultaneously, the People’s Bank of China announced that the daily trading band of 0.3% against the dollar would be maintained. Many analysts and economists believed that the real trade-weighted value of the renminbi was undervalued by up to 30% to 35%.
Companies that produce in China for the overseas market, retailers, and importers clearly benefit from an undervalued Chinese currency, as well as from the abuse of workers’ rights. On the other hand, companies actually producing in the foreign countries – whether for the domestic market or for export – face debilitating and unsustainable disadvantages from both currency manipulation and violation of workers’ right in China.
By 2004, the combined value of China’s exports and imports rose to 67% of its GDP, making China’s growth relied heavily on its international trading. The excess foreign exchange reserves resulting from the fixed yuan exchange rate was used as collateral to attract FDI inflows and support China’s development strategy – FDI brings useful technical and management skills as well as jobs to China. A sharp depreciation of renminbi will certainly reduce exports, increase unemployment, and force multinational companies with factories in China to shift production to other low-cost countries. However, the fixed exchange rate was expensive to sustain, and it also limited China’s flexibility in responding to a potentially overheating economy.
Summary of Q3
Chinese commercial banks face foreign exchange risk in three categories: banks’ capital exchange risk, asset liability net position risk, and the foreign exchange settlement risk. Yet Chinese banks’ company governance and international operation expertise are still far behind international competitors. A sudden change of foreign
International Finance
Executive Summary
On July 21, 2005, China revalued its decade-long quasi-fixed exchange rate of approximately 8.28 yuan per U.S. dollar by 2.1% to 8.11. Simultaneously, the People’s Bank of China announced that the daily trading band of 0.3% against the dollar would be maintained. Many analysts and economists believed that the real trade-weighted value of the renminbi was undervalued by up to 30% to 35%.
Companies that produce in China for the overseas market, retailers, and importers clearly benefit from an undervalued Chinese currency, as well as from the abuse of workers’ rights. On the other hand, companies actually producing in the foreign countries – whether for the domestic market or for export – face debilitating and unsustainable disadvantages from both currency manipulation and violation of workers’ right in China.
By 2004, the combined value of China’s exports and imports rose to 67% of its GDP, making China’s growth relied heavily on its international trading. The excess foreign exchange reserves resulting from the fixed yuan exchange rate was used as collateral to attract FDI inflows and support China’s development strategy – FDI brings useful technical and management skills as well as jobs to China. A sharp depreciation of renminbi will certainly reduce exports, increase unemployment, and force multinational companies with factories in China to shift production to other low-cost countries. However, the fixed exchange rate was expensive to sustain, and it also limited China’s flexibility in responding to a potentially overheating economy.
Summary of Q3
Chinese commercial banks face foreign exchange risk in three categories: banks’ capital exchange risk, asset liability net position risk, and the foreign exchange settlement risk. Yet Chinese banks’ company governance and international operation expertise are still far behind international competitors. A sudden change of foreign