Abstract
This paper studies the macro
economic trajectory of China with a special emphasis on its foreign exchange
management regime. This study comes at a time when china is facing
international pressures from across the globe to allow its currency renminbi appreciate.
Recently Robert Zoellick, President of the World Bank came out with his view
hinting of replacing dollar as the world’s reserve currency. The U.S.’s debt
burden will climb to 97.5 percent of gross domestic product next year from 87.4
percent, the Organization for Economic Cooperation and Development forecast in
June this year. Given that the US Dollar is losing its stability and
credibility, a need for shift to a more reliable value holder is felt across
the world. This paper studies whether renminbi can serve for that purpose or
not, given the skepticism around the world towards it's sustainability, albeit
the fact that it is the second largest economy and is the fastest growing
economy in the world. The rising prominence of renminbi got reiterated recently
when Malaysia bought renminbi denominated bonds for its reserves. It deals with
the renminbi’s current position in the global scenario, it's
increasing prominence, the benefits that
it is enjoying by means of
pegging it's exchange rate this lowly at the domestic context and at the international context, export and
import structure, their leverage over it's economy as a whole, capital market,
fund flow benefits, trade balance it maintains with nations across the globe
and how the other countries 's around
the domestic economy is affected by
china's export structure. To sum up, this paper is centered on china's foreign
exchange management regime .It deals with it’s correlation with the other
macroeconomic parameters.
______________________________________________________
* D.Gowtham, 2nd
year B.com, Loyola college, Chennai. Originally presented in the 'International
conference on recent trends in growth patterns – A Global perspective' held at
Loyola college, Chennai on 7th February 2011.
Sustenance of Renminbi and its leverage
over the world economy
Exchange rate
management regime:
Exchange rate
refers to the price of one country's currency expressed in another country's
currency. In other words, the rate at which one currency can be exchanged for
another. Countries often peg the value of their currency either above or below
the value of another currency to correct the trade imbalances that occur in
their economy relative to other economies. The exchange rate regime is the way
a country manages its currency in respect to foreign currencies and the foreign
exchange market.
On going practice:
Till 1971 all
world currencies except the dollar were pegged against dollar, which in turn
has agreed to maintain the value of 1 US dollar equal to the value of 35 Ounce
of gold. In 1971, following the inability of the dollar to maintain its value
as agreed in the Bretton woods system, world countries following West Germany
one by one started casting off the dollar as the world reserve currency, which
is popularly termed as Nixon shock. However, as United States remained the world's
preeminent economic power and as most of the international transactions
continued to be conducted with the United States dollar, it remained as the de
facto world currency.[1]Still
somewhere between 40 and 60 percent of international financial transactions are
denominated in dollars.[2]
Waning exclusive
hegemony of dollar:
Year
|
2001
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
2008
|
2009
|
Dollar's
Share in official foreign exchange reserves |
70.7%
|
66.5%
|
65.8%
|
65.9%
|
66.4%
|
65.7%
|
64.1%
|
64.1%
|
62.2%
|
Sources: 1995-1999, 2006-2009 IMF: Currency
Composition of Official Foreign Exchange Reserves Sources: 1999-2005
ECB: The Accumulation of
Foreign Reserve
Between 2000 and
2008 the US dollar’s share in the world countries’ official foreign exchange
reserves has significantly reduced from 70% to 62%. With the US unemployment
rate hovering around 10%, the exclusive economic supremacy of US that has been
enjoyed by it after the Second World War, would be uncertain in the forthcoming
times. Calls for replacing dollar as the primary world reserve currency has
increased in the recent times – particularly in the wake of 2008 global
financial meltdown. Zhou Xiao chuan, Governor of PBC called for a global
currency replacing dollar as the primary reserve currency pointing to Triffin
dilemma in 2009. In his speech he particularly mentioned about the need for
considering SDR for that purpose. Recently Mr. Zoellick, President World bank,
calls for a reserve system that “is likely to need to involve the dollar, the
euro, the yen, the pound and a renminbi that moves towards internationalization
and then an open capital account”. He also says that the system should also
consider employing gold as an international reference point of market
expectations about inflation, deflation and future currency values.[3]
US dollar’s real
effective exchange rate is as low as it was at the end of the Bretton woods
system in 1971. (Business Line, Tear down this Chinese wall) Former Federal
Reserve chairman Alan Greenspan in 2007 mooted the idea of having Euro as the
primary reserve currency in the place of US dollar. Thus one could not any
longer expect to have US dollar as the de facto world reserve currency.
Surging Chinese economic prominence:
China, with its
growth rate as the fastest in world, has raised skepticism around the world of
getting into the shoes of the US dollar. Recently it overtook Japan in the GDP
terms marking it as the second largest economy in the world after USA. Its
healthy state is very much evident from the fact its economic progress remained
intact in spite of the sovereign debt crisis that shook the world highly after
the sub-prime crisis of 2008. Being the holder of world’s largest labour force,
largest exporter of goods and services,
second largest importer, Fifth largest receiver of FDI, largest current account
surplus holder, holder of largest foreign exchange reserves adds up to its
credentials.
Renminbi in the
current global scenario:
In August 2010,
china opened its domestic interbank bond market to foreign central banks that
have access to renminbi through a series of bilateral currency swaps to the
worth of $120 billion. Commercial banks like HSBC, Citigroup were also opened
doors to invest in china’s inter bank bond market .Malaysia recently has
purchased renminbi denominated bonds for its currency reserves. Shanghai stock
exchange in November came up with its plan to issue Hong-Kong based ETF, the
first of a cross border investment kind in china. Such things add impulse to
the alleged China’s attempt to internationalize renminbi.[4]
China is also,
particularly after the wake up of the sovereign debt crisis, is facing mounting
pressures from across the globe particularly from the US to allow renminbi to
appreciate against artificially keeping its value low. This iterates the
inevitability of leverage of the renminbi in the world economic recovery. Thus
there is every possibility and right for renminbi to dominate the global
currency market in the future.
Forex management in
China:
In the year 1994
first major renminbi devaluation occurred to eliminate the current account insufficiency
that china has been facing thitherto. From then on current account of china
started showing steady rise of surplus - particularly after the China’s
accession to WTO in 2001. The unification of Swap rate and official exchange
rate into a single official exchange rate marked the first step in China’s
entering into the Managed floating exchange rate regime.[5]
YEAR CURRENT ACCOUNT BALANCE
|
In 2005 it gave
up it’s thitherto practice of pegging solely against dollar. Instead it started
adopting the practice of pegging its currency against a basket of currencies –
the major currencies in the basket being US dollar, European Euro, Japanese Yen
and the Korean Won. China revalued its renminbi against dollar to tune of 8.11
per USD moving away from its thitherto pegged value of 8.27 renminbi/USD. This
is where it is widely regarded that china has started adopting managed floating
exchange rate regime abandoning the fixed exchange rate regime. But in the wake
up of the 2008 financial crisis it halted the appreciation of renminbi against
the dollar. Between 2005 and mid 2008 renminbi appreciated against US dollar by
21%. Since then it remained roughly at 6.83 renminbi / US dollar. [6]
The exchange rate has been allowed to
move within a wider band, i.e., from a daily band of 0.3 percent against the US
dollar at the start of the reform in 2005 to 0.5 percent in 2007. Before 1994, the RMB exchange rate was determined
both by the authorities and the swap market. Now it is determined in the
interbank foreign exchange market through OTC transactions, supported by market
makers. In June 2010, the People’s bank of china announced that it would
allow renminbi to be more flexible, a move which was welcomed by the major
economies of the world. In December 2010, the exchange rate of renminbi was
roughly at 6.6 renminbi / US dollar.
Reason for being managed this tightly:
China cast off
the fixed exchange rate management regime in 2005. But that does not mean that
it has become considerably liberal in its exchange rate management regime.
Chinese economic growth is largely export driven. So its exchange rate should
be favoring its export sector.
The reason for
being so rigid in its exchange rate management regime is to gain competitive
advantage over the global countries. Its rigidity is very much evident from the
fact that china adhered to its exchange rate value of its currency during a
period when the world was suffering a global financial melt down from 2008 to
June 2010. China’s exports plunged by 21.3% during 2009 whereas the exports of
India, that is the second fastest growing economy and widely regarded as the
fitting competitor of china has declined by 29.2% during the global recession
period.[7]
The loosening of its hold in June 2010 is more
of an act of dousing international pressures. Its announcement came up during
the run up of the Toronto G 20 summit at which it was widely anticipated that
it is going to face condemnations against maintaining a strong hold over its
exchange rate. Thus china’s keenness in its management of its exchange rate
management regime can be attributed to the reason that it, by doing so, is very
much keen in spurring its export led growth. China’s cost advantage in the
products they export exceeds the 20 % to 30 % difference that a stronger Yuan
could achieve. [8]
Thus by not
allowing the, appreciation as asked by afflicted major economies it further
ensures its export driven growth.
Benefits that China enjoys by managing
their currency tightly at the domestic and international context:
By means of
maintaining its exchange rate this tightly it ensures price stability for
international dealers of the Chinese goods. This in turn attracts investors to
invest in Chinese economy, which ensures them a stable economic climate.
Thereby it is able to attract a large FDI into its economy. It has grown as the
third largest FDI receiver in the world in 2006.
In 2010 it has
grown as the second largest FDI attractor of FDI followed by USA.[9] This creates a good number of employment
opportunities in the country. Because of that it is able to maintain its
unemployment ratio at 4.2% albeit the colossal population it has. Given its
totalitarian regime, exchange rate regime that it follows renders it with a
good hold over the domestic demand. Since it does not go for frequent
adjustments of its exchange rate in relation to the international supply and
demand conditions it should go for adjustment in the domestic market to
maintain its exchange rate. So its domestic demand has to naturally get
calibrated to sustain its exchange rate. Thus its exchange rate management
regime facilitates government’s pursuits in its policies.
China has grown
as a country with the highest current account surplus by maintaining its
exchange rate to its favour. China has grown as the largest exporter of goods
and services. This has given it a competitive advantage over other countries.
So it is able to produce goods at low cost
.
Allowing minimal
appreciation of the renminbi has developed china as the largest holder of the
foreign exchange reserves. As of June 2010 its foreign exchange reserves has
grown to $2,454.3 Billion. Thus it endows China with enormous economic
potential. [10]
Export structure:
China’s share in
the total world exports jumped to 10% in 2009, replacing Germany as the world’s
largest exporter. Over the years China’s export structure has undergone drastic
change - from being a manufacturer of low value added products to high value
added products. Products such as electronic goods, telecommunication
instruments have found increasing presence in its manufacturing list while the
share of textiles, apparels has reduced. [11] The export identity of china has
been transformed from an exporter of low value added products to high value
added products.
China has been
able to sustain its export growth in real terms, which is hardly achieved by
any other country in the world. Its export is able to grow over time regardless
of the price fluctuations in the world trade. This senses the inevitability of
the China’s exports in the world trade.[12].China’s
export sector composition contains a major share of processing industry with
it. In other words, it is more a producer of intermediate or Semi-finished
goods.11 This states the fact that if the
exports of the China is affected it not only will affect its economy. Also the
economies of those countries from which it imports to manufacture those
intermediate goods will also get affected. This adds prominence to its export
sector in the world scenario and explains the reason for its export growth in
real terms. Over the ten years before 2008, China’s exports grew by an annual
average of 23% in dollar terms, more than twice as fast as world trade.
Projections in the IMF’s World Economic Outlook imply that China’s exports will
account for 12% of world trade by 2014. The China’s export share of 10 % in the
world trade is almost equal to that of Japan’s during 80-s. But Japan was not
able to sustain with that export growth rate – the reason being succumbing to
pressures across the globe to appreciate Yen – particularly from US. The Plaza
accord of 1985 allowed US dollar to devalue strengthening Yen. Yen strengthened
against US dollar by more than 100% between 85 and 88. Consequently its export
share dropped to less than 5%. China is facing such international pressures at
this moment. An IMF working paper published in 2009
calculated that if China remained as dependent on exports as in recent years,
then to sustain an annual GDP growth of 8%, its share of world exports would have
to rise to about 17% by 2020[13]
Can renminbi appreciation be a solution for
global economic imbalances:
Currently, China is running with a largest current
account surplus. It is maintaining trade surplus with major economies of the
world. In 2009 it was maintaining a current account surplus of $ 297 Billion. In
2005, the U.S. trade deficit with China was at $201 billion. It was followed by
the EU-15 which accounted for a deficit of $121.8 billion .It was followed by Japan
at $28.5 billion.
Thus
all the major economies are running in deficit with China in trade. [14]
Given
this kind of a trade dominance of china with the rest of the world it is a
matter of uncertainty that whether an appreciated renminbi alone can make up
for financial congestion that the world is facing. Since
joining the WTO, China provides one-fifth of American imports, but buys only
7.4 per cent of US exports. It has built up a bilateral trade surplus of $226
billion and, in the process, emerged as America’s banker. During late 2008 or
at early 2009 China became the largest foreign holder of US securities.[15] However US imports from China are mostly of
intermediate kind of goods, which are made up into finished products in the US.
Thus US imports from China are providing employment in US. A Centre for
Economic Policy research study states that reduction in US imports from China
will impinge negatively on its employment opportunities. The CEPR study
estimates that a 10 per cent rise in the value of the renminbi could see China
cut imports of components by as much as 6 per cent. The fact that China by
being an intermediate exporter, is not only at the receiver’s end but also is at
the giver’s end is reiterated from the fact that a 10% increase in China’s
income leads to 4 to 5 percent increase in the exports of countries like Japan
and Singapore. India too experiences a 2.3% increase in exports. India is a
latecomer, when compared to other countries, as a supplier of raw materials to
Chinese exports. [16]In 2009
US exports to China, which is the third largest importer of Chinese products
rose by 13%. Whereas in the case of Mexico and Canada, which are even the other
two largest importers of US goods than China, the import share has fallen by
14%. Thus it would not be just to deem China being very much mercantile in its
trade policy.[17]
Conclusion
China’s current
account surplus is driven not only by its large exports. The other factors that
account for its huge current account surplus are its prudent savings. Its
savings rate stands at 54 percent of GDP versus an average of 33 percent among
developing countries and 17 percent among Organization for Economic Cooperation
and Development Economies8. This high savings also largely
explains the reason for its current account surplus. In China state control is
large over the affairs. The government is totalitarian in its character. Given
such a kind of strict regime, it can be said that this kind of high savings is
largely driven by the state control. This can be better explained by the fact
that its savings comes from corporate sector rather than households. Given
their graying demographics, this high level of savings rate means that Chinese
are riding with a vision to ensure safety for their future. China is now at the
peak of experiencing its demographic dividend. China’s average age of
population would be 39 by 2020. By 2040, the world’s second largest population
after India will be Chinese pensioners, who would be more than 400 million in
number.[18]
Given the uncertainty over the productivity of china because of its enfeebling
demographics, China should act prudently now to sustain in the future. China
does this by means of saving much and maneuvering its exports prudently. Succumbing
to the capitalistic pressures from the west would prove to be mutually
detrimental phenomena .Because western countries know less about capitalizing
on the opportunities that a devalued renminbi would create. This can be substantiated by the Sub-Prime
crisis of 2008 that arose due to the speculative practices in US which
eventually ensued Asset bubbles in US. Already savings rate of US economy is
hovering at some point less than 1%.If China goes for currency appreciation it
may help the economy of US to pick up in the short run. But in the long run it
may not be possible because speculation may again start driving the economy of
US. This may result in asset bubbles. If china goes for a big appreciation of renminbi,
it also will have to face the ill effects of such appreciation. This is what
happened in the case of Japan in 1985. Japan lost its export market and
suffered an economic loss because of the currency appreciation, which is being
termed as the lost decade. So China should be prudent in managing its exchange
rate regime. Global economic recovery is essential. But that should not occur
at the cost of failure of healthy economies. So the ideal thing would be
allowing the renminbi to appreciate gradually, without allowing Chinese economy
to slack in the long run at the same time empowering the sickened economies by
making them to realize the seriousness by means of offering sustained resistance.
REFERENCES
[1]As of December 26,2010 Wikipedia
listed on its website http://en.wikipedia.org/wiki/World_currency
[2] Robert Gilpin, Global political
economy: Understanding the international economic order, 2001
[3]As of December 26, 2011 “Financial
times” listed on its website http://www.ft.com/cms/s/0/eda8f512-eaae-11df-b28d-00144feab49a.html#ixzz18viOCZzi
[4] As
of December 26,2011 “Financial times” listed on its website
[5]“A Managed Floating Exchange Rate Regime is an Established Policy”, People’s bank of China, accessed December 26, 2011,
[9] World investment report, UNCTAD,
2006, 2010
[11] Mary, Caroline, “China's
Export Boom’’, Finance and development 44, 2007
[12] Prof. Bhattacharya, Weekly current
affairs bulletin, A.I.R, 10th December 2010
[13] “Fear of Dragon”, Economist, 7th
Jan 2010
[15] Congressional Research Service
, China’s Holdings of U.S. Securities: Implications for the U.S.
Economy, July 30, 2009
[16] Nayan chanda ,Freeing the renminbi,
Business world, 24th April 2010
[17] Fear of Dragon, Economist, 7th
Jan 2010
[18] Helen qiao, Goldman sachs, BRIC
report, 2006
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