Renminbi Case Study

Contents

Executive Summary 2

The Past: Internationalising China 2

The Present: Government Interventions to Maintain Currency Valuation 2

The Present: Impact of Chinese Currency Devaluation on Other Countries 3

U.S. 4

Hong Kong & Singapore: Borrowing Shrinkages 4

S. Korea & Taiwan: High Direct Export Linkages 4

Philippines 4

The Present: China’s Direction 4

The Future: 2 Scenarios 6

China’s Struggles, U.S. Boom 6

China’s Acceleration, U.S. Slowdown 7

References 9

Executive Summary

The Chinese government and its policies were always unique and contrarian, and this has been extended to the management of its currency and economy as well.

This paper will look at the renminbi’s (RMB) past; how and who it affects or is affected by; changes implemented to manage the renminbi’s value; and future directions the renminbi may head towards.

The Past: Internationalising China

To understand the bigger picture of the renminbi depreciation, we should begin investigating the method in which the renminbi became internationalized, and the role it played in creating the current environment we are in. Also, we will assess how foreign trade and its forex reserve impacted the renminbi, and the consequences thereafter.

As China opened itself up to the world, it’s foreign trade volume has been steadily increasing – assisted by its inclusion in the World Trade Organization (WTO) in 2001 – and played a significant role in developing its economy. Due to its vast population size and cheap labour force, the strength of its exports and how it is tied to its economy can be seen in the trade volume difference before and after China’s inclusion in the WTO: in 1997, trade volume surpassed $300 billion USD; in 2004, trade volume exceeded $1 trillion USD (Zhang & Zhang, 2011).

The Present: Government Interventions to Maintain Currency Valuation

Due to pressure from the international community, the U.S. in particular, to float the RMB, China officially ended its fixed CNY/USD (pegged at 8.28 RMB to the dollar) on July 21, 2005. This switch to a float was managed within a narrow band relative to a basket of currencies consisting of the USD, Euro, Japanese yen, and Korean won (Morrison & Labonte, 2013).

This managed float was to promote a stable environment for foreign trade and investment in China as it prevented large fluctuations in exchange rates. To maintain the peg, China’s central bank, People’s Bank of China (PBC), had to buy enough assets in USD in exchange for newly minted RMB to eliminate the demand for the RMB. However, because the demand for a country’s goods and services would determine the exchange rates due to a floating exchange rate system, China’s RMB continued to appreciate against all other major currencies.

It was only because of the 2008 Global Financial Crisis (GFC) where PBC returned to a fixed CNY/USD to prevent further appreciations as the stronger RMB was hurting its exports, causing it to fall by 15.9%, resulting in thousands of factories closing, and millions of workers losing their jobs (Morrison & Labonte, 2013).

By the time China returned to the managed float structure in 2010, it widened its currency trading band from a daily range of 0.5% to 1% in 2012 to allow market forces to play a larger role in determining the valuation of the RMB. However, this was still heavily influenced and managed by PBC selling RMB in the domestic market in return for stockpiling foreign currency that flooded into China from Chinese exports – similar substance to the pre-2005 monetary policy albeit in a different form, managed float.

By 2013, this stockpiling resulted in an accumulation of more than $3.3 trillion USD in foreign reserved held by the PBC, which in turn fuelled accusations that China was deliberately undervaluing its currency to make its export market more attractive (Zhang & Zhang, 2011) – products from China would become cheaper in overseas markets, thus increasing exports (Guardian, 2015). Unsurprisingly, PBC devalued its currency further on two consecutive days, August 10 and 11, 2015, considering its poor economic figures.

The Present: Impact of Chinese Currency Devaluation on Other Countries

With the yuan depreciating by around 2% in 2015 and 2016, China developed twin goals for its approach. On the domestic front, a cheaper yuan would help Chinese exporters. However, too weak a currency will initiate capital flights from China that would be disastrous for its economy. On the international front, China does not want to get into a trade war with the U.S., which would occur if China had severely devalued its currency. Also, as China asserts itself more strongly around the world, too weak a yuan would not help its political purposes of increasing its global use.

This approach puts pressure on other central banks to push down their own currencies to help their own exporters, and to prevent destabilizing capital flows. Furthermore, it could hurt commodity markets as it signals potential weak demand from China, while accelerating capital flight from China, especially if investors expect further devaluations.

U.S.

Devaluation of yuan led to a postponement of U.S. interest rate hikes as a strong dollar and disinflationary impulse by other central banks might impact the U.S. economy negatively. Furthermore, the notion of substantial real decline in China’s growth prospects, which the forex movement indirectly signals, is not immaterial.

Hong Kong & Singapore: Borrowing Shrinkages

As people prefer to borrow in a depreciating currency, two of Asia’s financial hubs, Hong Kong and Singapore, were directly affected by the decrease in Chinese corporate borrowing.

S. Korea & Taiwan: High Direct Export Linkages

With 39% and 29% of exports to China by S. Korea and Taiwan respectively,