Since July 21, when the yuan appreciated 2.1 percent against the US dollar, it has crept up another 0.3 percentage points. This modest 2.4 percent increase, however, falls far short of the 10 to 15 percent appreciation hoped for by the US government, and this has caused dissatisfaction in Washington.
Ahead of US President George W. Bush's visit to China on Nov. 19, the governor of China's central bank, Zhou Xiaochuan (
Back at the end of April, Zhou declared that "reform of the exchange rate depends on internal reform pressures, and international pressure will be taken into account. If this external pressure increases, it will cause us to increase the pace of reform."
Zhou's statement is critical of Chinese economists for using over-simplistic models of how the yuan will reach equilibrium, which he says tend to underestimate "the flexibility of exports, the flexibility of imports and the flexibility of the domestic and foreign economies." In fact, according to recent findings by the IMF, predicting the exchange rate equilibrium for the yuan poses difficulties given the huge number of variables involved, in terms of which data to use and the most appropriate research model to adopt.
In the past, the Chinese government has insisted that adjustments to the yuan exchange rate need to be based on considerations of China's economy, so there must have been some research on the likely impact that changes in the exchange rate would have. Beijing has previously held the idea that a significant change would seriously damage the competitiveness of its exports and cause deflationary pressure, which would result in rising unemployment and social unrest.
If this is true, it seems Zhou has managed to mitigate the Chinese government's refusal to bow to pressure and shown them the sense of letting the yuan appreciate. Zhou certainly has a point here, and his approach is an improvement on the overly cautious one taken by the Chinese government in the past concerning the appreciation of the yuan.
First, over half of China's trade consists of processing re-export trade, and an appreciation of the yuan against the US dollar is sure to raise the dollar value of exports, at the same time as lowering the cost of imports, thereby balancing out the impact of appreciation on the competitiveness of Chinese exports.
Labor costs and local materials only account for 30 percent of the costs of Chinese manufacturing exports, and 50 percent of total export costs. Therefore, if the yuan appreciates by, say, 15 percent, Chinese exports will actually maintain their original price, and may even fall by 6 percent, in terms of their value in US dollars. This means that Chinese exports will actually be more competitive, not less.
Second, past experiences also indicate that nominal exchange-rate fluctuations of the yuan would not have a severe impact on China's export competitiveness. Between 1992 and 2003, the correlation between the yuan exchange rates and China's export-led economic growth stood at only 15.5 percent.
What's more, the correlation between the yuan exchange rate and the US export-led economic growth turn out to be minus 74.5 percent. That is, the yuan appreciates in inverse proportion to the growth rate of China's exports to the US.
In fact, during the 1990s, the appreciation of the yuan actually did not bring about a negative impact on China's economic growth. Between 1994 and 2002, although the trade-weighted real exchange rate of the yuan appreciated by 29 percent, China's economy still grew at the rate of 8.9 percent annually, without a single year showing less than 7 percent growth.
Although the Chinese government has in the past overestimated its economic adjustment costs brought about by the appreciation of the yuan, it still cannot be overly optimistic about the current situation, because China has already passed over the golden period when the yuan saw considerable appreciation.
At the end of 2001, China's foreign exchange reserves stood at US$212.2 billion. However, as of the third quarter this year, this figure had climbed to US$769 billion, an increase of US$556.8 billion, nearly half of which was the so-called "hot money" flowing into China from around the world. Such an amount is tantamount to 15 percent of China's GDP last year. The hot money might get remitted out of China after it benefits from the interest arbitrage of the appreciated yuan. If this happens, it will have a great impact on China as well as other Asia-Pacific nations.
Tung Chen-yuan is an assistant professor in the Sun Yat-sen Graduate Institute of Social Sciences and Humanities at National Chengchi University.
Translated by Paul Cooper and Daniel Cheng
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