Thu, Dec 09, 2010 - Page 9 News List

Revaluing China’s currency would boost its outward FDI

More direct investment by Chinese firms will force these companies both to compete on a level with other multinationals and to become good corporate citizens, which could help on the home front as well

By Karl Sauvant and Ken Davies

ILLUSTRATION: MOUNTAIN PEOPLE

So far, discussions about whether China should revalue its currency, the yuan, have focused almost exclusively on the impact of the currency’s exchange rate on China’s trade balance. But what would an appreciation of the yuan do to China’s inward and outward foreign direct investment (FDI)?

In evaluating China’s currency policy, the effects of any change on the trade balance are no more important than the potential consequences for inward FDI, which plays such a crucial role in China’s economic development, and China’s outward FDI, which is receiving increased attention worldwide.

China has been the developing world’s largest recipient of FDI since the mid-1990s. Revaluation of the yuan would make it more expensive for foreign firms to establish themselves (or expand) in China — the world’s most dynamic market — and would render exports of foreign affiliates, which account for 54 percent of total exports, less competitive internationally. On the other hand, the increased cost would be offset to some extent by lower-cost imported inputs, and foreign affiliates could expect to repatriate higher profits from sales in China in terms of their own currencies.

But the most notable development of recent years has been the surge in China’s outward FDI since the government adopted its “go global” policy in 2000, encouraging Chinese firms to invest overseas. China’s outward FDI more than doubled in 2005 to 2007, from US$12 billion to US$27 billion, and then more than doubled again in 2008, to US$56 billion. Outflows continued to rise to US$57 billion last year, a time when global FDI flows had collapsed by 50 percent, making China the world’s fifth largest outward investor.

The increasing international competitiveness of Chinese firms, together with government policy, has been the main driver of China’s skyrocketing outward FDI. The 20 percent revaluation of the yuan against the US dollar in 2005 to 2008 undoubtedly facilitated this in the case of recipient countries whose currencies did not also appreciate against the dollar.

China’s outward FDI is poised to increase sharply again this year, judging by the first half of the year, when it was rising at an annual rate of 44 percent. Revaluation would accelerate this trend.

This is precisely what happened in Japan after the yen was revalued by more than 50 percent against the dollar between 1985 and 1987, following the Plaza Accord. Japan’s outward FDI rocketed from US$7 billion in 1984 to US$20 billion in 1986, peaking at US$48 billion in 1990.

A renewed yuan appreciation would boost China’s outward FDI growth even further by lowering the cost of overseas assets for Chinese firms, which operate in a fairly competitive market and have strong cash reserves from both retained earnings and large-scale state credit allocations. Like competitors elsewhere, they need to invest abroad to acquire a portfolio of local assets that give them better access to the markets, skills, technology and natural resources that they need to protect and strengthen their international competitiveness.

The revaluation effect would be reinforced by rising wage pressures inside China, which are already leading some labor-intensive Chinese firms to invest abroad (there are more than 700 Chinese affiliates in Vietnam alone). Some of these firms have been weighing whether to move production abroad or to inland provinces of China; revaluation could push them in the former direction.

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