The Effect Of RMB Revalue To The Economy Of China - Dissertation Example

? The effect of RMB revalue to the economy of China Contents 3 Introduction 3 Literature Review 4 Objectives of Dissertation 8 Research Questions 8 Method of Analysis 8 Outline of data 9 Conclusion 9 Reference 11 Abstract The research study will take into consideration the revaluation of RMB and the effect it had on the economy of China. The revaluation of RMB has been in the limelight in the recent discussions on political and economic affairs. The politicians of U.S. are of the opinion that revaluation of the RMB will act as the solution in problems of trade deficit. But the reality is that the current trade deficit that U.S. has with China is mainly because of the prevailing economic conditions in U.S. So the trade deficit that is affected by RMB is negligible (Hong Kong Industrialist, 2005/6, p. 15). Introduction The director of Peterson Institute for International Economics blamed the undervaluation of the currency of China for job losses in the country of United States. The director also drew a plan of action if China did not withdraw the control of currency and permit the renminbi (RMB) to gain strength. The central bank of China known as the People’s Bank of China allowed for some relaxation. The bank announced that will abandon the two year old peg. The peg has kept the RMB with the dollar (Yu, 2010, p. 2). It allowed RMB to respond according to the forces of the market. China will now begin to move into the regime of floating exchange rate. The regime will be a tight one which was in practice in the period between 2005 and 2008. The value of RMB will be the base on a basket of currencies within a narrow range (Wharton University of Pennsylvania, 2010). China believed that the stable RMB policy is good for the country from the time of the financial crisis of Asia. The country turned away from the exporters who were reported for violating the standards of pollution. The strengthening of the RMB against the U.S. dollar has continued unabated since 2005. It will follow the stable rising path since the country is under intense inflationary pressure (Wang and Whalley, 2007, p. 3). Literature Review Economists are of the opinion of further 10-15 percent revaluation (Yuann and Inch, 2008, p. 219). Since 2003, the pressure of RMB appreciation triggered. The expectation on appreciation of RMB was postponed during the global financial crisis. The appreciation of RMB will affect the aggregate demand through two canals. The appreciation will cause pressure on the supply of money. This will lead monetary expansion in cases where sterilized intervention is not sufficient. The aggregate demand and prices of the assets will get stimulated. The imbalances between demand and supply will increase because of the expectations associated with trade surplus and speculative inflows of capital. The monetary authorities will buy the excess supply of foreign exchange in the market in order to maintain stability in exchange rates. The growth in assets of foreign currency was much more than the growth of base money. The growth of foreign assets even crossed the rate of growth of broad money. This puts pressure on the monetary authorities to fasten down the monetary growth. The growth of money will be out of control if measures of sterilized intervention cannot keep up to the task. The growth of assets of foreign currency has dropped below the growth rate of broad money after the financial crisis. In the long run, the growth rate of broad money will settle in the usual level and short term capital will start to enter into the economy of China and this will again put the supply of money under pressure. But even if the monetary authorities are able to control the stable growth rate of money supply, then also the expectation for appreciation of RMB will stimulate the aggregate demand and prices of the assets will rise. Once the appreciation of RMB is expected, the expected returns on the assets that are risky will increase and price of these assets will take the steep rising path. The value of the collateral will rise even if the supply of broad money remains stable. The actual cost of the loans will fall and the aggregate demand will get stimulated (Sang Ho and Wong, 2011, p. 190). A revaluation of RMB will help China and its competitors to compete with the country. The growth of the country will also be more balanced. If the revaluation of RMB is not accompanied by acceleration in the domestic demand of the country, most countries will not witness small benefits. Some of the countries may even loose as the import prices will rise. The current account deficits with China will broaden for at least a year or two. United States will list its name among the losers. Many economists are of the opinion that any estimate of RMB undervaluation should be taken with a grain of salt as many assumptions are taken into account. Current account surplus of the country will remain unexplained by an undervalued renminbi. Savings rate of households, fiscal balance and other incentives which are offered to investors as well as exporters play an important role. The leaders of Beijing recognized that gradual appreciation of RMB will serve their own interests as it would increase the purchasing power of the consumers. Between the month of July 2005 and 2008, the amount of appreciation was 20 percent against the dollar. After the suspension because of the financial crisis the policy was resumed on June, 2010. Since then the currency has appreciated by only 2.2 percent. The domestic demand of the country has increased by 41 percent since 2006-07. Again the current account surplus has declined by 5 percent of its GDP. The country contributed 30 percent of growth globally over the period of 2000 to 2008. The financial market has become sensitive in the country as the markets are in the economy of United States. But the process of revaluation of RMB will be in vain for the country or its trading partners if it acts as a constraint to the export dependent economy. It can also undermine the confidence of investors in the growth continuation process (Dadush and Ali, 2010). The net exports and fixed investment which is linked with the tradable sector contributed for more than 60 percent of the growth of the country from the period of 2001-08 (International Monetary Fund). There will be balance sheet effect and economic effect because of the revaluation. The former refers to the future effects on the economy while the later refers to the immediate effects. The revaluation of RMB is likely to have small and positive impact on the balance sheet of total wealth of the country. Wealth transfers will take place within the country dictating the winners and the losers. Exporters and manufacturers who operate in the tradable goods sector will lose. They expect the revenues to be in dollars while costs are mainly in RMB. This implies that the value of future revenue will fall compared to the value of the expenses in the future. The wealthy Chinese will also be in losing situation. A big group of losers is constituted by the Chinese who are stocks of goods and services whose prices are set internationally. Because of the revaluation, those prices will drop in terms of RMB and if the purchased assets were financed by borrowing in terms of RMB, they will incur a loss. An undervalued RMB has the effect of distorting the international trade as it shifts the resources from households to the wealthy class and subsidizes the manufacturers in the tradable goods sector. A revaluation is part of the rebalancing mechanism. But costs are associated with rebalancing. The current industrial policies of the country sacrificed the income of the households with the aim to spur the growth in manufacturing. This will automatically reduce unemployment the level of the household’s income will take the steep path upwards. So by repressing the income growth of the households the country has actually been able to achieve rapid growth. However the growth was based on hiding the true costs behind the subsidies. So the real economic growth is likely to be lower than the economic growth that was recorded. China is dependent highly on exports which are sensitive to price. A large revaluation of RMB for only once can carry risks which are unacceptable to the growth and stability conditions. A double shock may be felt by countries like United States if China faces the problem of sharp slowdown. Revaluation can have massive and significant effects. The global financial market felt the massive significant effects when the PRC begins in transition into the World’s largest economy. The revaluation process can accelerate of flow of speculative money into the economy. It may also mark its peak in the present cycle of capital flows. But in the short term the country is likely to face dangers. The country is facing the internal troubles and external threats and so they need to move very carefully in currency matters. The Chinese economy looks strong from outside but it still faces the problem of feeding the largest population. Movement of hot money may be triggered by such revaluation. The repercussion is negative on the Chinese economy of migration of hot money taking profits. In response to various debates, China will adopt a policy that will be responsive to the market conditions i.e. changes in demand and supply conditions will shed its impacts on the adopted policy. Apart from the external constraints, other factors will also influence the decision of the policy makers as the government of China follows the principles of independence. Revaluation will have negative impact on exports for a short time. This will optimize the structure of trading of the country and will also relocate the resources to the non trading sectors. The service sector will reap the benefits as the profits from advanced technology would accrue to them. The domestic demand of the country will get promoted which will support the economic growth. The economy will gradually nullify the dependence on external demand (Zhang, n.d. p. 3). Foreign investment has contributed largely in the reform of the country and it has also opened up various policies for further economic growth. The Chinese authorities are also concerned about the impact of the revaluation of RMB on foreign investment. The revaluation will increase the cost of investment as well as the profits will get enhanced as revenue will also increase. The impact will be more or less neutral. As a result of the revaluation of the RMB, the prices of the agricultural products which are in terms of this currency will be dragged down. But there will be increase in domestic demand for agricultural imports (Zheng, Yi and Chen, 2007, p. 11). Objectives of Dissertation The objective of the dissertation is to identify the impacts of the revaluation of RMB on the economy of China. Research Questions The research questions are as follows: Is revaluation of RMB a fruitful situation for the economy? If so why, and if not, then why not? What are the different types of effect that revaluation of RMB will have on the economy and the different internal and external factors of appreciation of exchange rate of RMB. Method of Analysis In the method of analysis the previous researches will be taken into account and stress will be given on assessing the impact of the revaluation on the economy. The different effects namely the balance sheet effect and the economic effect will be taken into consideration. To answer the research question it is necessary to include both types of data-primary and secondary. In this case secondary research will form the base of the study as primary research in the form of questionnaires is not possible. Secondary data are those which have already been collected from some source for the purpose of research. The research will put emphasis on three types of secondary data namely documentation, multiple sources and surveys. Research may also be based upon books and publications of government departments. The publications of the trade organization will also be taken into account. Constraints on resources and possibilities limit the research in use of secondary data. Techniques of quantitative analysis which will help the researcher for further research process will also be used. Emphasis will be given in order to determine the existence of any trend within the research data. Statistical techniques in excel will be used after the process of data collection is over. Some of the selected areas will have descriptive analysis. The qualitative data needs to be analyzed and infer the underlying meanings. Outline of data With the aim to meet the requirements of the research questions it was necessary to provide an introduction that talk about the exchange rate regime and the evolution of RMB revaluation in the picture. Data that can shed its impact on the economy of China at all levels have been taken into account. The impact of the appreciation of RMB has also been considered. In addition literature review provides the idea on the various undergone researches and opinions. Conclusion All the consumers of China whose consumption basket consist of imported goods are likely to benefit from the revaluation. This will constitute the largest part of consumers except the farmers. The rise in the value of RMB will cause the prices of the imports to fall. Therefore, a revaluation will increase the wealth of the country by increasing the real value of both types of assets-current and future as well as income. A revaluation will shift the wealth from the government and the wealthy class to the households. This is what is meant by rebalancing in the Chinese economy. The other means of rebalancing will have the same effect. All the means will ultimately increases the share of consumption in GDP. The greatest beneficiary because of the revaluation will be the country itself. The country will witness balanced and resilient growth. This will have a positive spill over across the globe and will reduce the currency and tensions of trade. Some middle income exporters of manufacturing goods are likely to benefit from the revaluation (Britton and Mark, 2006, p. 12). The remaining exporters who import a loss from the country will lose in the short run as the price of exports will rise. But in the long run they will gain as they will be able to expand the volume of trade at the expense of the country. The commodity exporters who belong to the low income category is likely to lose. They can acquire the benefits only if appropriate measures are taken by the Chinese authorities. The conclusion does not indicate or support judgment on the bilateral trade deficits for other countries with China (McNelis, 2006, p. 5). It only asserts the fact that revaluation of RMB is not the way to take of the problem of deficit. A more effective measure would be to increase the national savings rate in United States and Italy. Reference Wharton University of Pennsylvania. 2010. China's Renminbi Revaluation: Small Step, Big Impact? [online]. Available at: http://knowledge.wharton.upenn.edu/article.cfm?articleid=2538. [Accessed:9th April, 2012]. Yuann, J. and Inch, J., 2008. Supertrends of Future China. [online]. Available at: http://books.google.co.in/books?id=R_LoB6JvstIC&pg=PA218&dq=rmb+revaluation&hl=en&sa=X&ei=KMGCT_uTMsLWrQeAg4mFBg&ved=0CDYQ6AEwAQ#v=onepage&q=rmb%20revaluation&f=false. [Accessed:9th April, 2012]. Sang Ho, L. and Wong, J. 2011. APEC and the Rise of China. [online]. Available at: http://books.google.co.in/books?id=pXRK2hk6KokC&pg=PA188&dq=rmb+revaluation&hl=en&sa=X&ei=F8CCT8uVHo6srAeuv7joBQ&ved=0CD0Q6AEwAg#v=onepage&q=rmb%20revaluation&f=false. [Accessed:9th April, 2012]. Hong Kong Industrialist, 2005/6. Reasons for RMB Revaluation and its Impacts. [online]. Available at: http://www.industryhk.org/english/fp/fp_hki/files/HKI6covereng.pdf. [Accessed:9th April, 2012]. Dadush, U., and Ali, S., 2010. Who Will Gain from a Renminbi Revaluation?. [online]. Available at: http://carnegieendowment.org/2010/12/09/who-will-gain-from-renminbi-revaluation/2exj. [Accessed:12th April, 2012]. International Monetary fund, 2009. China’s economy.[pdf]. Available at: http://imf.org/external/pubs/ft/wp/2009/wp09172.pdf. [Accessed:12th April, 2012]. Zheng, Y., Yi, j., and Chen, M. 2007. REVALUATION OF THE CHINESE CURRENCY AND ITS IMPACT ON CHINA. [pdf]. Available at: http://www.nottingham.ac.uk/cpi/documents/discussion-papers/discussion-paper-24-chinese-currency-revaluation-and-impact.pdf. [Accessed:11th April, 2012]. Zhang, X. n.d. The Economic Impact of the RMB Revaluation. [pdf]. Available at: http://www.cfses.com/06confchina/documents/ZhangXiaohe_Economic_Impact_RMB_Revaluation.pdf. [Accessed:11th April, 2012]. Britton, E., and Mark, C. 2006. Assessing the effect of U.S. economy of trade and investment with China. [pdf]. Available at: http://www.chinabusinessforum.org/pdf/the-china-effect.pdf. [Accessed:11th April, 2012]. McNelis, P. 2006. Renminbi Revaluation, Euro Appreciation and Chinese Markets: What Can We Learn From Data? [pdf]. Available at: http://www.bnet.fordham.edu/crif/WorkingPapers/CRIF06003.pdf. [Accessed:11th April, 2012]. Wang, L., and Whalley, J., 2007. THE IMPACTS OF RENMINBI APPRECIATION ON TRADES FLOWS AND RESERVE ACCUMULATION IN A MONETARY TRADE MODEL. [pdf]. Available at: http://www.nber.org/papers/w13586.pdf. [Accessed:11th April, 2012]. Yu, M. 2010. Does Appreciation of the RMB Decrease Imports to the U.S. from China? [pdf]. Available at: http://en.ccer.edu.cn/download/6843-1.pdf. [Accessed:11th April, 2012]. Read More