Perspective on International Trade and Finance - China - Case Study Example

Perspective on International Trade and Finance Table of Contents Executive Summary 3 Introduction 4 Analysis of the Case Issues 5 Arguments of the different parties 5 Impact and determinants of the exchange rates 5 Valuation of the Renminbi 7 Impact of revaluation 8 Options available for China to reform its exchange rate regime 9 Conclusion 10 References 12 Executive Summary This paper accentuates on the trade disputes in relation to the exports made by Chinese manufacturers to foreign countries across the world, particularly the developed nations. Though after the entry to the World Trade Organization, China had exposed itself to large scale foreign transactions; it has not yet created trade standards akin to the developed countries. As a result the manufactures located in China often have an unfair advantage owing to China’s non-enforcement of strict standards and its manipulation of its currency. This paper focuses on the trade disputes involving China, the impact and the determinants of foreign exchange rates, the valuation of the Chinese currency before and after the reforms. This paper also discusses the options that are available to China for reform of its exchange rate system. Introduction The level of exports by China had amplified radically from $250 billion in the year 2000 to a proposed $1,500 billion in the year 2009. This massive increase of Chinese exports severely hampered rival businesses in the developed countries, predominantly the Europe and the United States. In 2001, China entered the World Trade Organization (WTO), which ascertained China the right to export to countries like US and the Europe. Nevertheless, the entry to the WTO necessitated China to stick on to certain regulations that were required to endorse fair trade and generate a level playing ground for all. Various issues such as the safeguard of intellectual property, labour and environmental benchmarks, health and safety apprehensions about Chinese products, Chinas management and manoeuvring of their currency, and expenses and prices established by the government instead of the free markets gave rise to a number of trade disputes. This paper investigates the different types of trade disputes and the endeavours made by China to solve them. A lot of disputes were rooted in the Chinese cultural practices as well as in ideological outlook and hence take time to resolve. Deficiencies in the legal and court arrangement in China also effected the enforcement of various rules. Additionally, many of the disputes originated due to the governments wish to guard the welfare of Chinese organizations and their workforce, and consequently China might modify its practices only if faced with convincing penalizing threats. The central government of China also encountered the "principal-agent" crisis where its decisions or requests could be overlooked by the local governments and organizations. In the meantime, modifications in business structure within the developed countries were changing the negotiation positions of the governments of those countries (Conklin & Cadieux, 2009). Analysis of the Case Issues Arguments of the different parties After the entry into the WTO, China started taking part in international trades. However, China did not impose criminal procedures and punishments on the infringement of intellectual property rights; neither did it build identical health and safety standards that were implemented in the western countries. The extensive health and safety, along with the labour and environmental regulations in the developed countries, added the expenses involved for the manufacturers located there. Since China did not enforce such strict standards, the Chinese manufacturers had unfair advantage over the western ones. Moreover, China did not honour the property ownership of western manufacturers because the Chinese manufacturers were creating employment and promoting domestic prosperity via counterfeiting. But this activity of Chinese manufacturers hurt the volumes of sales and the profit margins of the western manufacturers. China even encouraged its exports by lowering its currency value below the level that would have been agreed on in the international exchange free market. As a result of this foreign exchange manipulation, foreigners could buy the Chinese products at a lesser price, thus booting Chinese exports. This practice was considered as an unfair competition by foreign rival companies (Conklin & Cadieux, 2009). Impact and determinants of the exchange rates The exchange rate of a particular nation’s currency determines the price at which it trades for another currency on the exchange market. The exchange rate amid the currencies of two nations is referred to as the bilateral exchange rate. It is defined as the number of units of either currency required to buy one unit of the other. The bilateral exchange rate is influenced by various issues. The major issues influencing the exchange rate comprise of interest rates, inflation, and foreign exchange reserves among others. It is imperative for transnational business organizations to recognise the determinants of exchange rates and whether the exchange rate variations can be forecasted (Jacque, 1997). The currency of each nation is valued in relation to the currencies of other nations by means of the exchange rates. International trade and transaction require currencies to be exchanged. The values of majority of the currencies vary over a period of time owing to the forces pertaining to the market and the government policies. When the value of the currency of a particular nation rises in comparison to other currencies, then its current account balance declines. This is because as the value of the currency appreciates, the products sold by that nation to other overseas nations would become more costly to the importing nations. As a result, the demand of the products of that nation will decline leading to reduced balance in its current account (Sullivan, 2009). There are various determinants of the variations in the exchange rate of a particular currency, for instance terms of trade, investor sentiments, purchasing power parity, monetary and fiscal policies, economic growth rate and international parity conditions among others. In general, these determinants can be classified as short-term, medium-term and long-term determinants of exchange rate (Ajami & Goddard, 2006; Ajami et al, 2006). The figure below depicts this classification of determinants of exchange rate movements: Figure 1: Determinants of Exchange Rate Variation. (Source: Jeffus, 2010) Valuation of the Renminbi Since the year 1994, the central bank of China, People’s Bank of China had pegged the Chinese currency Renminbi in a constricted margin at approximately 8.28 Renminbi to the United States Dollar. By pegging the Renminbi, China had restricted the appreciation of its currency. Considering the vast economic expansion of China during the last decade, countries like Unites States and Europe have condemned the pegging of the Chinese currency and have demanded to permit Renminbi to float freely and gradually increase in value (Earnshaw, 2005). Till the mid of 2005, the Renminbi /US dollar exchange rate varied inside a range of 0.1%, that is, 1 US dollar = 8.27 to 8.28 Renminbi. Fundamentally, the exchange rate structure in China, also known as the US dollar-peg arrangement, has become a type of rigid exchange rate regime. The goal of the dollar-peg exchange rate system was to accomplish a reasonable exchange rate, so as to encourage and endorse exports and bring home foreign currency. This characteristic exchange rate system has played an imperative function in the steadiness of the economy of China during the last twenty years (Eiji& Michiru, 2006). Impact of revaluation In July, 2005 China decided to revalue the exchange rate of Renminbi to the US dollar by 2%. As already discussed, prior to that, the exchange rate arrangement was virtually preset. The fresh exchange rate system that was implemented after the reform comprised of a managed floating exchange rate system with regards to a basket of currencies. According to the new regime, alterations in the rate of exchange variation will not only administer the association amid the Renminbi and U.S. dollar, but also amid the Renminbi and other major currencies across the worls, for instance, the euro and the yen. Furthermore, China has also implemented a thin band of 0.3% on both side of the fundamental rate inside which the Renminbi can alter against the US dollar (Gin, 2009). Regardless of the official declaration that China has stopped pegging the Renminbi to the US dollar, and instead substituted it with a reference collection of currencies, the U.S. dollar has persisted to carry on an important function for exchange rate determination of Chinese currency, Renminbi, even after 2005, i.e. subsequent to the valuation reforms. Concurrently, the currencies like euro and yen play a negligible function on Renminbi’s value. Even though certain studies have suggests that the extent of independence in the exchange rate management of China amplified subsequent to the reform (Gin, 2009), this barely substantiates that a currency basket management is essentially in effect. To put it in simpler words, the exchange rate of the Renminbi/US dollar has not become more flexible following the exchange rate modification by China in 2005. Consequently it is rational to consider the exchange rate management reform of China since the year 2005 as one of the ongoing advancement. Nonetheless, so as to avoid elevated domestic inflation and lessen the stress of the trade superfluous with United States, the Chinese central government should attempt to make the exchange rate of the Renminbi more flexible in the coming days (Gin, 2009). Options available for China to reform its exchange rate regime China should implement an exchange rate system that is more flexible, considering the magnitude of the country’s economy, its fast paced economic advancement, comparatively elevated inflation as against the United States and the Europe, in addition to the expanding global financial assimilation owing to its entry to the WTO. If the rate of inflation of China rises in comparison to that of the nations with which it conducts business, then it is likely that the current account of the nation would decline, other factors remaining the same. In such a circumstance, the customers as well as the business houses in China would buy more number of products from a foreign country. At the same time the level of exports of China to the overseas markets would reduce to a large extent owing to the high rate of domestic inflation (Madura, 2009). If the income level of China rises at a higher rate than those of other nations, then its current account is likely to decline, other factors remaining stable. With the increase in the real income level of China, this is adjusted for inflation; the level of consumption of goods also increases. A fraction of that increase in expenditure will most probably be a sign of an augmented demand for overseas products (Madura, 2009). External aspects such as rising reserves, restrained inflation, limited domestic credit growth and the present capital controls might support the steadiness of foreign exchange rate in China. However, the enlarged exposure huge imports of petroleum, price volatility, unstable exports owing to the existing trade protectionism in developed countries like the United States and the Europe, inadequate foreign currency liabilities, regular appreciation of Renminbi are likely to endorse exchange rate flexibility in China. Conclusion The currency of each nation is valued in relation to the currencies of other nations by means of the exchange rates. International trade and transaction require currencies to be exchanged. The values of majority of the currencies vary over a period of time owing to the forces pertaining to the market and the government policies. When the value of the currency of a particular nation rises in comparison to other currencies, then its current account balance declines. This is because as the value of the currency appreciates, the products sold by that nation to other overseas nations would become more costly to the importing nations. As a result, the demand of the products of that nation will decline leading to reduced balance in its current account. The government of a nation can have a strong influence on the qualitative aspects of investment appraisal, by means of its guidelines on subsidising exporters, limitations on imports, or requirement of enforcement on piracy. At times, the government provides subsidies to the country-based organizations enabling them to manufacture goods at a lesser expenditure than their international rivals. This increases the export demands of these organizations. At the same time, the government can also check the imports from other nations. Such type of trade restrictions are generally in the form of tariffs and quotas. References Ajami, R. A. et al., 2006 International business: theory and practice. USA: M.E. Sharpe. Ajami, R.A. & Goddard, J., 2006. International business: theory and practice. USA: M.E. Sharpe. Conklin, D. W. & Cadieux, D., 2009. China’s Trade Disputes. Richard Ivey School of Business Foundation. Earnshaw, G., 2005. China Business Guide 2005: The Top Source of China Business Information for 15 Years. China: SinoMedia (Holdings) Co. Ltd. Eiji, O. & Michiru, S., 2006. Chinese Yuan after Chinese Exchange Rate System Reform, China & World Economy, 14 (6), 39–57. Jacque, L.L., 1997. Management and Control of Foreign Exchange Risk. USA: Springer. Jeffus, W.M., 2010. Exchange Rate. Retrieved from: Jin, G., 2009. Examining the Exchange Rate Regime for China. International Research Journal of Finance and Economics, Issue 25. Madura, J., 2009. International Financial Management. USA: Cengage Learning. Sullivan, D., 2009. International Business. India: Pearson Education. Read More