Impact of Yuan Appreciation

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The Economic Impact of the Chinese Yuan Revaluation
Xiaohe Zhang School of Economics, Politics and Tourism Faculty of Business and Law The University of Newcastle. Callaghan, NSW 2308, Australia Telephone: 612-49215034 Fax: 612-49216919 Email: James.Zhang.@newcastle.edu.au Abstract Since the beginning of the economic reform process in 1979, the Chinese currency (yuan) was devalued on many occasions until 1994 when the two-tier foreign exchange system was ended. While the official rate of yuan had been maintained constant over seven years since 1998, the pressure on the revaluation of yuan intensified. After years of speculation and hearsay, China finally revalued the RMB by 2.1% in July 2005. There are arguments currently on how and to what extent the official rate of the yuan should be further revalued. However, due to a de facto real appreciation of the yuan relative to its neighbor countries since 1994, the competitiveness of China’s exports has been reduced. It would be therefore very difficult for the Chinese authorities to allow the yuan to revalue considerably in the near future. This paper attempts to offer a quantitative evaluation of several policy scenarios in reference to the yuan revaluation through simulating a multi-country macroeconometric model (the Fair Model). According to the results of the simulations, the revaluation of RMB would not be appealing to the Chinese. To some extent it would further reinforce the deflation, reduce the competitiveness of China’s exports and the growth of GDP. As a result, some additional policies may need to be implemented to remove the adverse impact of the yuan revaluation.

Paper prepared for the 18th Annual Conference of the Association for Chinese Economic Studies Australia, “China: Internal Challenges and Global Implication in the New Era: Strategies for Sustainable Economic Growth and Business Responses to Regional Demands and Global Opportunities.” Melbourne, Australia 13-14 July 2006. I am very grateful for the valuable comments by Professor Martin Watts, the School of Economics, Politics and Tourism, The University of Newcastle.

The Economic Impact of the Chinese Yuan Revaluation
1. Introduction Since the economic reform started in 1979, the Chinese currency (yuan) had been devalued several times until 1994 when the two-tier foreign exchange system was ended. While the official rate of yuan had been maintained constant over seven years since 1998, the pressure on the revaluation of yuan intensified. It has been perceived by some economists that the yuan is undervalued on an order of 15 to 35% (Frankel 2006, Zhang and Pan, 2004, Chang and Shao, 2004, Goldstein and Lardy, 2003, among others). After years of speculation and hearsay, China finally revalued the yuan by 2.1% in July 2005. While the currency remains effectively pegged to a basket of hard currencies, it is allowed to fluctuate against the US dollar (USD) by less than 0.3 per day in either direction. However, the issues on whether, when and to what extent the official rate of the yuan should be further revalued remain unsolved. Some American politicians, as the representatives of the manufacturers and labour unions, believe that the undervalued yuan is responsible for much of the U.S trade deficit (it reaches $800b in which about one fourth of it is with China), while other commentators, such as Tung and Baker (2004), and Frankel (2006) argue that further revaluation of the yuan serves China’s own interest so a considerable revaluation is deadly needed. Though the decision over yuan revaluation becomes more political when some “external” pressures from the USA, Japan and Europe intensified over the last two years, the Chinese authorities, nevertheless, are still reluctant to revalue the yuan further. They insist that China’s banking system and financial institutions must be improved before floating the yuan is considered. This may also be due to a fear of losing further competitiveness in China’s...
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