Renminbi revaluation

Abstract

China has maintained a fixed de-facto exchange rate of the Chinese Renminbi against the US dollar since 1994. Since the exchange rate has been fixed despite China’s remarkable growth and accumulating trade and current account surplus in the last decade, US and many of China’s trading partners believe that the Renminbi was substantially undervalued. They have been trying to urge the Chinese government to either revalue the currency or move to a more flexible exchange rate mechanism. Finally, the Chinese government appreciated the Renminbi by 2.1% on July 21st 2005. Since then, the Renminbi has appreciated further but many experts opine that the upward revaluation has not been enough. This paper is structured into four sections. The first section looks at the unsustainable global imbalances in the current account positions of several countries and draws the conclusion that a major revaluation is needed in the major currencies of the world in order to correct it. The second section looks at the issue of revaluation from China’s perspective. The Chinese government now wants to put China on a consumption driven growth path rather than an export driven growth path. In order to do so it must significantly modify its exchange rate policy. The third section seeks to answer the billion dollar question about China’s exchange rate policy – Does China manipulate its currency? In the fourth section we quantitatively determine the impact of a possible revaluation of the Renminbi on trade with India. While the first three sections set the context for the problem, the fourth section looks at the impact of exchange rate change. The analysis was carried out using regression analysis between the dependent variable real exports and the independent variables GDP of India, real exchange rates and volatility. From this, we conclude that if the relative costs in India and China do not change and the Chinese currency appreciates against the dollar and INR does not appreciate to the same extent i.e. the Renminbi appreciates against the rupee, then the nominal imports from China go down. Thus, the exchange rate revaluation is found to have a significant effect on the trade between India and China. It is important to understand how a possible revaluation in the Renminbi will impact trade between China and a partner trading country. This can help countries prepare for such situations better. This becomes more important as China continues to pace ahead and pressures keep mounting on it to revalue its currency upwards.