For Chinas Struggling Economy, 2016 May Be Worse than 2015 - Assignment Example

Fоr Сhinа’s struggling есоnоmy, 2016 mаy bе wоrsе thаn 2015” Word count: 1466 (a) The main issue that is discussed in the article is that in 2015, China’s economy experienced one of the weakest growth rates in 25 years, and that 2016 will more difficult. The issues identified as contributing to the poor economic performance are structural inefficiencies and the government’s half-hearted push for economic reforms. The article discusses what the Chinese government has done as part of efforts to revive economic growth. Such efforts include creating a monetary stimulus, creating a stock market bubble and creating a bond market bubble. However, despite these efforts, China was facing even more economic difficulties at the time of writing the article. This was reflected in the collapsing commodities market, which saw China’s CRB index decline by 15 per cent in 2014 and by a further 27 per cent in 2015. The article also discusses measures that can be used to remedy China’s situation by noting that the government should develop a detailed plan to facilitate economic stability, absorb recurrent losses, and ensure a balance in the economy. Some of the approaches to be applied include shifting incomes to the household sector by reducing contributions to social welfare schemes and reducing income tax and consumption. (b) The demand and supply model of exchange rate determination is based on the demand and supply of the foreign currency vis-à-vis the domestic currency. For instance, in the case of China, the domestic currency is the yuan while the foreign currency is the US dollar, which is commonly used as the medium of exchange in international transactions. In this view, the sources of supply of the US dollar are foreigners who want to buy goods or services from China and pay using the US dollar. Sources of demand are domestic residents in China who want to import goods or services from other countries and therefore have to pay for their purchases using the US dollar. As noted by Jain and Khanna (2010, p. 316), foreign investors purchase domestic goods using foreign currency, hence supplying foreign currency to the domestic exchange market (in this case China). In the same way, domestic investors that want to invest in foreign assets cause demand for the foreign currency. Further, a larger demand for foreign currency against a low supply of foreign currency causes an increase in the exchange rate relative to the value of the foreign currency (Jain & Khanna 2010, p. 316). What this means is that if the demand for the US dollar increases and the supply of the US dollar is low, then more yuan units will have to be paid in exchange for each US dollar. In contrast, a larger supply of the US dollar against the yuan will reduce the demand for US dollars, meaning that the exchange rate decreases or fewer yuan units are paid for each US dollar. The factors that influence fluctuations of the exchange rate include government intervention, differentials in inflation and interest rates, current account deficits, economic performance and political stability, terms of trade, and public debt (Peng 2015, p. 450; Whittington & Delaney 2010, p. 132). (c) The yuan has fluctuated significantly against the US dollar (USD) since 2013. For instance, as of December 2013, the exchange rate was 1 US $ = 6.05 Chinese yuan (Exchange Rates UK 2016). The exchange rate as of 20 March 2016 was ­1 US $ = 6.47 Chinese yuan (CNY) (Trading Economics 2016). Over the three years between 2013 and 2016, the exchange rate has gone up and down, driven by a number of factors. For instance, between January 2013 and December 2013, the yuan was relatively very strong. This is exhibited by the fact that the exchange rate in January 2013 was slightly above 6.2 Chinese yuan to the US dollar, and the value of the yuan strengthened over the following months such that by December of the same year, the exchange rate was CNY 6.05 to 1 USD (Trading Economics 2016). This can be seen in the graph (figure 1) below. Figure: Yuan exchange rate against the US dollar, January 2013 to March 2016. Source: Trading Economics (2016) According to S.C. (2013), one of the main reasons why the yuan was so strong in 2013 is that the cost of labour in China had increased significantly over the preceding 10 years, which caused an increase in the cost of the country’s exports. This caused China’s exports to slow down, and consequently, the yuan appeared too strong against the dollar. In 2014, the yuan had fallen 2.4 percent by the month of July due to lack of growth of China’s economy in the first quarter of the year (Reuters 2014). It is important to note that China’s annual gross domestic product (GDP) growth fell from 7.7 per cent in 2013 to 7.3 per cent in 2014 (The World Bank Group 2016). As it can be seen in figure 1 above, the yuan exchanged at more than CNY 6.2 for the US dollar in the period around April to June 2013, having been below the CNY 6.2 = 1 USD mark in the preceding period. The reason why the yuan weakened during this period is that the People’s Bank of China – China’s central bank – had set a weaker reference rate for the yuan (Trivedi, Iosebashvili & Cui 2015). The effect of this is that the value of the yuan against the US dollar depreciated, and the weaker currency was meant to tackle the effect of weakening exports and inflation (Trivedi, Iosebashvili & Cui 2015). In 2015, the yuan continued the fluctuation trend, exchanging at slightly above CNY 6.2 to one US dollar. However, as shown in figure 1, the yuan fell sharply around august 2015 to exchange at about CNY 6.4 to one US dollar. This behaviour was caused by the fact that in August 2015, China devalued its currency, leaving it 1.9 per cent weaker against the US dollar (Tejada 2015). A further weakening of the yuan was experienced at the start of 2016, as shown in figure 1. Notably, the yuan-US dollar exchange rate rose to more than CNY 6.6 to the US dollar in January 2016. This was driven by the Chinese government’s decision to let the yuan fall as a way of making China’s exports more competitive in the world market (Rosenfeld 2016; Wilder 2016). (d) Part 1 By saying that China’s current economic challenges are caused by the country’s ‘inefficient governing system’, Xie (2015) is implying that the Chinese government’s approaches to dealing with the economic problems are ineffective. Notably, Xie (2015) has pointed out that the government of China has tried approaches such as monetary stimulus, stock market stimulus and bond market bubble – all of which have failed. Further, the government is now bent on ‘playing with monetary policy’ through approaches such as devaluing the currency in order to boost investment demand (Xie 2015). But as noted by the same author, such a strategy will also not work because China already has an overcapacity in terms of investment. In regard to ‘right reforms’, Xie (2015) has noted that the current reforms that the government of China is implementing are not encouraging. The right reforms that Xie (2015) is referring to are measures such as the government having a reduced role in the economy and having in place practical approaches that will help stabilise the economy, absorb cyclical losses and ensure a balance in the economy. Examples of the right reforms include shifting incomes to households by reducing contributions to social welfare funds and reducing consumption so as to have more funds available for investing in the economy. Part 2 I do agree with the statement because as noted by Xie (2015), the Chinese government seems to be focusing solely on monetary policy issues such as stimulus packages and devaluing the currency to spur investment and growth. The problem with such measures is that they are only beneficial in the short-term. This is evidenced by the failure of the monetary stimulus, stock market stimulus and bond market bubble to have any meaningful impact on China’s economy. According to the OECD (2009, p. 128), monetary policies such as stimulus packages only work if they are implemented in a timely manner when required and adjusted or removed thereafter. From the article by Xie (2015), the Chinese government has been coming up with such packages without assessing their timeliness or adjustment/removal once their relevance is over. As well, the Chinese government has been devaluing the currency to boost investment, but as noted by Xie (2015), the country is already faced with overcapacity. Devaluation can also reduce investor confidence and reduce export gains (Sinha 2010, p. 22; Wolf, Jr. 2002, p. 142) since China is also an importer. The Chinese government should therefore focus on ‘right reforms’ that promote economic stability. References Exchange Rates UK 2016, US Dollar to Chinese yuan (USD CNY) for 31 December 2013 (31/12/2013), viewed 20 March 2016, . Jain, TR & Khanna, OP 2010, Macroeconomics and elementary statistics, V.K. Publicastions, New Delhi. OECD 2009, OECD economic outlook: interim report March 2009, OECD, Paris. Peng, X 2015, Financial theory: perspectives from China, World Century Publishing Corporation, Hackensack, NJ. Reuters 2014, ‘China agrees to reduce FX intervention’, CNBC, 10 July, viewed 19 March 2016, < http://www.cnbc.com/2014/07/10/china-agrees-to-reduce-fx-intervention.html>. Rosenfeld, E 2016, ‘Chinese yuan: here's what's happening to the currency, CNBC, 7 January, viewed 20 March 2016, . S.C. 2013, “Why is the yuan so strong?”, The Economist, 20 June, viewed 20 March 2016, . Sinha, NK 2010, The Pearson complete guide for the CAT, Dorling Kindersley, New Delhi. Tejada, C 2015, ‘5 things to know about China’s currency devaluation’, The Wall Street Journal, 10 August, viewed 19 March 2016, . The World Bank Group 2016, GDP growth (annual %), viewed 18 March 2016, . Trading Economics 2016, Chinese yuan, viewed 20 March 2016, . Trivedi, A, Iosebashvili, I & Cui, C 2015, ‘China’s yuan falls to seven-month low’, The Wall Street Journal, 26 January, viewed 19 March 2016, . Whittington, OR & Delaney, PR 2010, Wiley CPA exam review: business environment and concepts, John Wiley & Sons, Inc., Hoboken, NJ. Wilder, D 2016, ‘Renminbi weakness: China’s challenge for 2016’, Financial Times, 4 January, viewed 20 March 2016, . Wolf, Jr., C 2002, Straddling economics and politics: cross-cutting issues in Asia, the United States and the global economy, RAND, Santa Monica, CA. Xie, A 2015, ‘For China’s struggling economy, 2016 may be worse than 2015’, South China Morning Post, 23 December, viewed 18 March 2016, . Read More