International Financial Management: China - Essay Example

International Financial Management Question Both the international trade and economic growth in chinaare growing at a high rate in recent years making the country target global markets. The high level of growth may be attributed to a stable political system, availability of natural resources and abundant skilled labor in China. The active participation of china in international trade may also contribute in making the country a global economic powerhouse. China initiated economic reforms and adopted an open-door economic policy to participate more in international trade. The result of the policy was an increase in the country’s international trade and economic growth. The countries integration into the global economy made it one of the world’s economic powers. Openness to international trade is important in establishing economic growth of a particular nation (Tian and Yu 28). International trade ensures expansion at the global scale promotes technological development and allows institutional changes for countries. China’s international trade expanded rapidly since the adoption of the opening policy that opened the global market for china and other nations. An analysis of china’s major trade partners in 2008 indicated that the E.U, the U.S. and Japan are the major international trade partners of China. It is evident that the leading trading partners of china are also the leading trade countries in the world. The international trade between china and leading trade partners may have contributed to country’s economic success (Peng and Almas 10). Question 2 China experienced surpluses in both current and capital accounts in from 2002 to 2008 as indicated in table 1. The presence in China’s current account may be due to the country’s exceptional economic growth. According to Anderson (62), the surplus in the current accounts resulted from net trade of heavy industrial products. The increase in trade was due to an earlier domestic boom in these industrial products coupled by an earlier increase in demand for these products. During the same time, there was an increase in national savings that came from the corporate sector particularly the industrial sector. Therefore, It is evident that the increased current account surplus came from the rise of savings over investment trade. An increase in export trade and a decrease in growth rate of exports may have also contributed to increased surplus in the current account. The economic development in china does not fit the economics of development phenomenon that emphasizes on developing countries running current account deficits but running surpluses on capital accounts, using foreign savings to achieve a higher investments rate. Rather china runs “twin surpluses” characterized by both large capital account and current account surpluses. The continued twin surpluses result in a consistent increase in foreign exchange reserves. China registered surpluses in current and financial accounts due to expansion in international trade and inflow of foreign direct investment. China’s international reserve assets equaled 1,493,816.17 million USD in 2008 majority of which is kept as foreign exchange reserves. The country accumulated the surpluses in most of its major accounts through selling more than it is buying in the international markets. The stockpiling of a lot of cash in domestic official reserves rather than spending or reinvesting international may have also contributed to the surpluses (Izabella 1). Table 1: China, mainland Balance of payments Summary (USD million dollars) Metadata           2005 2006 2007 2008 Balances Current Account Balance 132,378.49 231,843.04 353,182.68 420,568.52 Capital Account Balance 4,101.79 4,020.11 3,099.07 3,051.45 Financial Account Balance -159,727.28 -239,365.48 -369,518.55 -442,478.53 Net Errors and Omissions 23,247.00 3,502.33 13,236.80 18,858.57 International Investment Position         Net IIP 413,474.33 640,164.09 1,188,115.45 1,493,816.17 Total IIP Assets 1,229,107.14 1,690,429.64 2,416,204.27 2,956,691.07 Total IIP Liabilities 815,632.81 1,050,265.55 1,228,088.82 1,462,874.90 Data Source: Balance of Payments Statistics (BOP) extracted from IMF Data Warehouse Question 3 The current exchange rate between the Chinese Yuan and the US dollar is such that 1USD equals 6.13 Chinese Yuan. In 2012 and 2013 the USD equaled to 6.31and 6.15 Chinese Yuan respectively. The trend from the past two years is that the Chinese Yuan has been weakening as indicated in table 2. The Chinese exchange rate regime continues to evolve. The Chinese Yuan old pattern of on-gain and off-gain appreciation was replaced by the largest depression ever in twenty years. In the short term, there is a likelihood of appreciation towards the end of 2014. The appreciation in exchange for the Chinese Yuan in relation to the US dollar is due to the increasing international trade between china and other countries such as the EU. China’s trade surplus is widening and its exports to advanced economies are improving. However, this short-term appreciation trend may be replaced by a long-term weakening of the Chinese Yuan to 6.0 in 2015 as the country central bank implements the decision to increase the space at which its currency is trading in the international market. The decision by the central bank was deliberate because it targeted in improving the nation’s economy through manipulating the foreign exchange regime (Hoffman, Fuacher and Adams 2). According to the Balance of Payments approach, changes in exchange rate regimes can influence currency exchange rate between two trading partners. However, changes in relative prices of commodities in the US and China may also contribute to the trend in which the Chinese Yuan is depreciating against the US dollar in the long-term. China offers a huge export market for the US and also the second largest trading partner for the US. Increasing international trade between these two countries may affect the prices of commodities being traded. With the increasing production of Chinese commodities, prices may fall especially in the international market. The result may be the weakening of the Chinese currency against the US dollar. The reducing rate of china’s economic growth may also participate in weakening its currency. According to the International Monetary Fund 2014 data, the economic growth rate for china was 9.2 percent in 2011, 7.8 percent in 2012 and 7.7 percent in 2013. The reduction if percentage economic growth rate coincides with the weakening of the Chinese currency during the same time. Such trends mean that the exchange rate may fall in the long term. The Purchasing Power Parity Approach argues of the relative importance of interest and inflation rates in determining forecasting foreign exchange rates. The deficit rate in China’s fiscal policy increased from 2.2 percent to a rate of 3 percent from 2013 to 2014. Making changes to the fiscal policy to stimulate economic growth may have effects on the country’s exchange rate. Table 2: Historical Chinese Yuan Rate (CNY) Year CNY/USD   Year CNY/USD 1999 8.28 2008 6.95 2000 8.28 2009 6.83 2001 8.28 2010 6.77 2002 8.28 2011 6.46 2003 8.28 2012 6.31 2004 8.28 2013 6.15 2005 8.19 2006 7.97 2007 7.61       Source: PNC Forecasts 2014 Work Cited Anderson. "Chinas Industrial Boom and the Renminbi." Goldstein and Lardy. Debating Chinas Exchange Rate Policy. Washington DC: Pearson Institute for International Economics, 2008. Hoffman, Stuart, Gus Fuacher and Williams. Adams. Dollar Still has Room to Trend Stronger in 2015-2016 after 2013-2014s Large Gains. Pittsburgh: The PNC Financial Services Group, 2014. IMF. "Chinas Economic Growth rate." 2014. Izabella, Kaminska. "Its not easy having loads of FX reserves." FT Alphaville 12 May 2014. Peng, Sun and Heshmati. Almas. International Trade and its Effects on Economic Growth in China. Discussion Paper. Bonn: The Institute for the Study of Labor (IZA), 2010. Tian, Wei and Miaoje. Yu. "China and India:Trends in trade over the last decade." The Journal of China and Global Economics, Vol. 1, No. 1 (2012): 27-38. Read More