A gradual renminbi revaluation will help China and a few other countries that compete with China. It will also make China’s growth more balanced and resilient, which is in the general interest.
However, unless China’s revaluation is accompanied by an acceleration in its domestic demand, most countries will see little benefit and some countries will lose as their import prices rise and their current-account deficits with China widen, at least over the next year or two1. Ironically, the US, which has been leading the charge on renminbi appreciation, would likely be among the losers. Certainly, a very large one-off revaluation that disrupts China’s growth hurts everyone.
Renminbi undervaluation and China’s growth
Various studies have suggested that the renminbi is undervalued, with recent estimates ranging from 15%-50% (see for example Evenett 2010). China’s very large interventions in support of its currency (its reserves have increased by 40% to $2.6 trillion since the crisis began two years ago) lend credence to the view that its exchange rate is undervalued.
Many economists (for example, Corden 2009, McKinnon 2010, Mundell 2010, and myself) believe that any renminbi undervaluation estimate should be taken with a grain of salt, since it requires many assumptions and China’s current-account surplus cannot be explained primarily by an undervalued renminbi. Instead, factors such as the household savings rate, fiscal balance, taxes and other incentives offered to investors and exporters play a more important role.
Recognising that a renminbi revaluation increases the purchasing power of its consumers and is in China’s own interest, Beijing’s leaders have allowed the renminbi to gradually appreciate, amounting to 20% against the dollar between July 2005 and July 2008. While the policy was suspended when the global economic crisis began, it resumed in June 2010. Indeed, China’s currency has appreciated by about 2.2% with respect to the dollar since then.
China’s pre-crisis revaluation – combined with its massive demand stimulus – has served both the country and the world well so far. China’s domestic demand has increased by 41% since 2006-2007, and its current-account surplus has declined by 5% of its GDP. China has contributed about 30% (in Purchasing Power Parity terms) of global growth over 2000-2008. Indeed, global financial markets have become as sensitive to developments in the Chinese economy as they are to those in the US economy.
But renminbi revaluation will not work for either China or its trading partners if it disrupts China’s highly export-dependent economy and undermines the confidence of investors in its continued growth. According to the IMF, net exports and fixed investment linked to the tradable sector accounted for more than 60% of China’s GDP growth from 2001-2008, compared to 35% in the rest of Asia and 16% in the G7 economies.
Evaluating the effects of renminbi revaluation is not straightforward. Renminbi revaluation causes a loss to consumers outside China since they will confront higher prices of goods imported from China. These losses have to be offset against those of producers who will gain competitiveness. Moreover, China’s trading partners are more likely to gain from renminbi revaluation if it comes with measures that accelerate China’s domestic demand relative to its GDP. Indeed, without those measures, the effect of renminbi revaluation on China’s current-account surplus is likely to be marginal – it may even widen it.
Renminbi revaluation will have differentiated effects on China’s three broad classes of trading partners: low-income commodity exporters, middle-income manufacturing exporters, and high-income manufacturing exporters. The effects of renminbi revaluation on high-income countries will be mixed and will depend on their bilateral trade position with China (see Table 1).
Table 1. Trade with China in 2009 (% of country's current dollar GDP)
Low-income commodity exporters benefit from China’s continued expansion, as China has attracted an increasing share of their exports – about 7.2% in 2009, up from 1.3% a decade before. Furthermore, China has become an important source for them of cheap consumer goods as well as machinery, accounting for about 17% of their total machinery and transport equipment imports.
In the very long run, a revaluation of the renminbi could help commodity-exporters to diversify into basic manufacturers. However, over the next few years, renminbi revaluation is unlikely to affect these countries’ exports significantly because the prices of their commodity exports are determined in global markets (and denominated in dollars). However, the dollar prices of China’s exports to those countries are likely to rise, reflecting small profit margins in those sectors and the fact that China, as the biggest exporter of those goods, is the price-setter.
As a result, countries that have largest trade deficits with China, such as Ghana, for example, will be more likely to lose because of the deterioration in their terms of trade (a measure of the difference between the growth of export and import prices). Thus, the commodity exporters are likely to have a much greater interest in China’s continued growth than in renminbi appreciation. According to an OECD study, a 1% slowdown in China’s growth rates will result in a reduction of around 0.3% in growth of low-income economies.
Middle-income manufacturing exporters which show a bilateral trade surplus with China and which compete directly with China in manufacturing exports, such as South Korea and Malaysia, are likely to gain the most from renminbi revaluation as they become more price competitive with China in other markets. Like China, some 45-50% of the exports of these manufacturing exporters is accounted for by machinery and transport equipment.
Yet not all will benefit. Some middle-income manufacturing exporters such as Vietnam or Hungary have also been relying increasingly on imports sourced in China – nearly 12% of their imports in 2009 came from China – and will see their import prices rise with renminbi revaluation.
The effects of renminbi revaluation on high-income countries will be mixed and will depend on their bilateral trade position with China, which generally reflects smaller deficits as a share of GDP than that of the low- and middle-income countries. The price of their imports from China will rise. However, in countries such as Germany and Japan, this effect will be at least partly offset by their ability to increase prices on their large exports to China. Because the technology-intensive and differentiated nature of their exports makes them less price sensitive, their exporters may choose to leave their renminbi prices unchanged and take increased profits. Yet since they do not, for the most part, compete with China directly, they are unlikely to see large gains in other markets or long-term volume gains from renminbi revaluation.
The US and Italy are in a less favourable position because their imports from China are about three to four times larger than their exports to China. As a result, they are likely to be significant net losers from renminbi revaluation and see their bilateral trade deficit with China widen unless offset by a substantial acceleration in China’s growth. The rise in the price of their imports from China (consumed widely and disproportionately by low-income households) will outweigh the profit-enhancing effect of the rise in the price of their more sophisticated exports to China.
Moreover, in both the US and Italy, the widening of the bilateral trade deficit with China may become permanent because neither import nor export volumes are likely to react enough to offset the large terms-of-trade deterioration.
While the discussion above has outlined some of the winners and losers, the greatest beneficiary from a gradual renminbi revaluation, accompanied by measures to stimulate demand, will be China itself. Its growth is likely to be more balanced and resilient, and that will have a positive spillover on the rest of the world, including by reducing currency and trade tensions.
This conclusion does not imply a judgment that a large bilateral trade deficit in countries such as Italy and the US with respect to China is good or bad. It only implies that renminbi revaluation is not the way to fix the deficit problem. Instead, increasing national savings rates in Italy and the US, and increasing consumption in China would be more effective.
Given China’s high dependence on price-sensitive exports, a large one-time renminbi revaluation may carry unacceptable risks to its growth and stability. In the event of a sharp slowdown in China, those countries that are likely to lose from renminbi revaluation anyway, starting with the US, could suffer a proverbial double whammy.
Corden, W Max (2009), “China’s exchange rate policy, its current account surplus, and the global imbalances”, Economic Journal, 119(541).
Evenett, Simon J (ed.) (2010), The US-Sino Currency Dispute: New Insights from Economics, Politics, and Law, A VoxEU.org Publication, 15 April.
McKinnon, Ronald I (2010), “China Bashing Over Yuan Needs a Long Rest: Ronald I. McKinnon”, Bloomberg.com, 6 July.
Mundell, Robert (2010), quoted in Judy Shelton, “Currency Chaos: Where Do We Go From Here?”, The Wall Street Journal, 16 October.
1 In the economic literature, the initial (one to two year) widening of the trade surplus in the event of a revaluation is known as the J-curve effect, and reflects the fact that export and import prices react much faster than volumes.