free floation of chinese yuan

8/7/2019 Free floation of Chinese Yuan

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FREE FLOATATION OF

THE CHINESE YUAN

CRITICAL ANALYSIS OF ITS

IMPACT ON US AND INDIA


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Prepared By-

Sunaina Kain- 16004

Siddharth Mehta- 16044

Raghav Srivastava- 15956

Keshav Dogra- 16037

Rohit Kirar- 16051


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AGENDAo Introduction

I. History of Chinese Currency

II. Fixed Rate v/s Floating Rate

oChinese Exchange Rate and its

Undervaluation

oChinas take on free floatation

I. Chinas viewpoint

II. UNCTADs opinionoUSAs Concern

o Implication on India

oSynopsis


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INTRODUCTION Renminbi or Yuan was always officially pegged to

the USD, hence China has always had a fixed

currency regime

Chinese Yuan - 30% to 50% undervalued. Pegging lead to current account surpluses for china

and deficit for America.

Peg was lifted on 21st July, 2005 and Yuan was

allowed to free float and helped China to followflexible exchange rate system.


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HISTORY THE RENMINBI RMB:Peoples Currency

Unit is Yuan () round coin

1 Yuan

y

10 Jiao 100 Fen

Issued by Communist Party in 1948 beforewinning the war and establishing PeoplesRepublic of China

Revaluation in 1955 to end hyperinflation at 1 new Yuan = 10 000 old yuan

From 1994-2005 Yuan was pegged to dollar atthe rate of 8.2/$.


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FLOATING EXCHANGE RATE

Currency's value allowed to fluctuate

according to the foreign exchange market

Floating exchange rates automatically adjust

In cases of extreme appreciation or depreciation,

a central bank will normally intervene tostabilize the currency, known as managed float

No need ofmaintaining high level offoreign

reserves.

High chances of speculation in the rates inorder to make personal profits


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FLOATINGRATE V/SFIXEDRATE

BASIS FLOATINGEXCHANGERATE

FIXEDEXCHANGERATE

Determined by Private market

through demand and

supply

The government

How it works Works on auto

correction mechanism

Works on the fixed

rate given by the govt.

Need to maintain

foreign reserves

No such need There is a need to

maintain high level of

foreign reserves

Speculative tendencies High chances of

speculation

Quite less


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HOWISTHEYUAN VALUED ?

From 1994 until July 2005, China maintained a policy of

pegging its currency.

At an exchange rate of roughly 8.28Yuan to the dollar

Chinas foreign exchange reserves grew from $403 billion in

2003 to

$2.27 trillion as of September 2009

$3.83 trillion as of Sept 2010

Chinese Govt. modified its currency policy on July 21,

2005

Yuan now became, adjustable, based on market supply

and demand with reference to exchange rate movements

of currencies in a basket


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exchange rate of the U.S. dollar against the Yuan was

adjusted from 8.28 to 8.11, an appreciation of2.1%.

From July 21, 2005 to July 21, 2009, the dollar-RMBexchange rate went from 8.11 to 6.83, an appreciation of

18.7%.

U.S. imports from China rose by 5.1% over the previous

year, compared to import growth of 11.7% in 2007;

U.S. exports over this period were up 9.5% compared withan 18.1% rise in 2007.

China appears to have halted its currency appreciation

policy around mid-July 2008.

Generally averaged 6.83Yuan per dollar throughDecember 1, 2009


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Chinastarted

maintaining

a policy ofpegging rate

Yuan becameadjustable,

US imports

from chinarose by 5.1%,

US exportsfrom china

rose by 9.5%

US importsfrom china

rose by 11.7%,

US exportsfrom chinarose by 18.15

Chinaappears to

have haltedits currency

appreciation,

Generallyaveraged 6.83

Yuan perdollar

Chinasforeign

reserves from$403 billionin 2003 to

$3.83 trillionas ofSept

2010

1994

2005

2007

2009

2010


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CNY/USDMOVEMENTS


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YUAN TO USDRATES OF 2010


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ALLEGATIONSAGAINSTCHINA

China is alleged to devalue its currency ( 15% to 40%)

Unlike a true floating exchange rate, the RMB would be allowed tofluctuate by up to 0.3% (later changed to 0.5%) on a daily basis


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Makin false commitments to deflect criticism inthe G20 summit

Accumulating foreign reserves


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Chinas exchange rate policy is holding backglobal growth.

Appreciation of the RMB halts further lossesfrom $1 trillion US held assets.


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CHINASCONCERNOVERMODIFYING

ITSCURRENCYPOLICY

It might hamper economic stability

Spark an economic crisis

They further argue that Chinese banking

system is too underdeveloped Economic stability critical to maintaining

political stability

Could cause employment disruptions

This might cause worker unrest


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ECONOMIST VIEWSONTHEINTENT

BEHINDCHINASDECISIONON

YUANFLEXIBILITY

Both domestic compulsions and external pressure

were responsible for China to allow its currency to

float within the intra-day trading band of +/- 0.5

percent.

Domestically, a stronger exchange rate would:

- transforming the growth structure from

being export led to domestic consumption

- tackle the inflation situation

By allowing its currency to be flexible, china has

managed todouse trade tensions with the US and

EU as well.


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CHINASTAKEONFREEFLOATATION

The current exchange rate system is benefitting

china in the following ways:

Exports and foreign direct investment:

China as a responsible stakeholder:

Avoidance of trade tensions

Protecting the value of chinas investment


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OPINION BY UNCTAD

Imbalances of theglobal economy cannotbe resolved by a free

floating Chinesecurrency

Burden of rebalancingthe global economy

should not be put on asingle country and its

currency

"to leave currencies tothe vagaries of themarket" would not

help solving theproblem

Imbalances in worldtrade and the global

economy lie insystemic failures,require

comprehensive andinclusive multilateral

action


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MOVEMENT OF YUAN


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CURRENT SITUATION OF YUAN


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USAS CONCERN


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PURCHASING POWER PARITY

MODEL (PPP) PURCHASE POWER PARITY (PPP)

Based on the Law of one price.

E.g. Big Mac Index ( The Economist )


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PURCHASING POWER PARITY

MODEL (PPP)

y 2004: 1 USD = 2.021 yuan

y 2005: 1 USD = 2.047 yuan

y 2006: 1 USD = 3.462 yuan

y 2007: 1 USD = 3.621 yuan

y 2008: 1 USD = 3.798 yuan

INTERNATIONALMONETARYFUND


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LIMITATIONS OF PPP

PPP does not take into

consideration:

Purchase patterns

Difference in quality of goods in

different countries

Inflation


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Chinas Exportdriven Economy

Problem ofUnemployment

Weaker ExchangeRate Increases

Demand

WHY IS THE YUAN UNDERVALUED ?


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Factors Responsible for Revaluation

PoliticalFactors

Pressurebetweengovernments

Rapid Growth

EconomicalFactors

Cheap ChineseManufacturing

Rapid Growth ofMNCs setting

upmanufacturing

base

Impact onChinese

Companies


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AMERICAN TRADE DEFICIT

y China contributes with 20% of

US Trade Deficit

y

Appreciation of RMB willaffect the deficit

y The impact is proportional to

the overall trade

y

China contributes with 11% ofUS Trade


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IMPLICATIONONCHINESE

ECONOMY

Export orientedeconomic growth has led

to inexpensive Chinesegoods which haveinvaded marketsglobally.

Low inflation and high

financial stability

Large reserves decreasethe susceptibility toexternal shocks.

Long term

Fuel inflation,

overinvestment. Expansion of

nonperforming loans bythe banks

Opportunity Costs

Sacrificing purchasingpower over imports

Accumulated foreignreserves could have beenused to pay foreign debts

Advantages Disadvantages


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Effect on borrowers


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Effect on consumers


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U.S.-CHINATRADEAND

MANUFACTURINGJOBS

Manufacturing Employment Change in Manufacturing

(Thousands) Employment: 1995/2002

Total Change Percent

1995 2002 (Thousands) Change

United States 17,251 15,304 -1,947 -11.3

Japan 14,570 12,230 -2,340 -16.1

Germany 8,439 7,963 -476 -10.1

United Kingdom 4,402 3,956 -446 -10.3

South Korea 4,796 4,241 -555 -11.6

China 98,030 83,080 -14,950 -15.3


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IMPLICATIONS ON INDIA

Indo-China Trade Relations

Indias Trade deficit

Dual impact of revaluation

Implication of stronger Yuan How India will benefit from Yuan appreciation ?

Where will Rupee go as Yuan revalues ?


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INDO-CHINA TRADE RELATIONS

Trade relations date back to ancient times

1984- first trade agreement is signed

1992- full fledged bilateral trade relation

1993- border agreement is signed 1994- double taxation avoidance agreement

signed

2003- Bangkok agreement signed

2005- trade started growing significantly 2010- bilateral trade relations expected to reach

$30 billion by end of 2010


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INDIAS TRADE DEFICIT India reported a balance

of trade deficit of

US$9118.0 million in

September, 2010.

Indias major exportitems are gems,

jewellery, leather

goods and textiles.

Indias major import

items are coal,

machinery, fertilisers

and chemicals.


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INDIAN IMPORTS FROM CHINA/CHINESE IMPORTS FROM INDIA

JAN 2009- JAN 2010 (US$)

India imports China imports

Jan-09 2.06 billion 861 million

Feb-09 1.75 billion 1.14 billion

Mar-09 2.22 billion 1.31 billion

Apr-09 2.39 billion 1.35 billionMay-09 2.35 billion 1.02 billion

Jun-09 2.26 billion 927 million

Jul-09 2.78 billion 979 million

Aug-09 2.69 billion 799 million

Sep-09 2.67 billion 1.42 billion

Oct-09 2.44 billion 935 million

Nov-09 2.78 billion 1.19 billion

Dec-09 3.29 billion 1.78 billion

Jan-09 2.81 billion 1.82 billion


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DUALIMPACTOFREVALUATION

Chinese exports would become expensive. Thusother nations have a better chance to compete as

exporters.

Chinas foreign exchange reserves of $2.3 trillion

would get devalued. This includes holdings of US

treasuries of $798.9 billion, as of September

2009.

Chinese imports would become cheaper and

which would give the government a strong tool to

manage inflation and increase the purchasingpower of the people


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IMPLICATION OF STRONGER YUAN

Indias trade deficit with China in 2009 was US$

15.8 billion.

Stronger Yuan will help in eliminating this

deficit and would also help in increasing thw cost

of Chinese imports to India which would benefit

Indian manufacturers.

A higher Yuan would also slowdown American

trade deficits and thus cap the American trade

deficit

Yuan revaluation could have a marginally

positive effect on Indias trade account.


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CONCLUSION

an undervalued RMB neither increases nor

decreases aggregate demand in the

the gains and losses in employment andproduction caused by trade deficit will not be

dispersed evenly across the regions of the

economy: on balance, some areas will gain while

others will lose.

If output in the trade sector falls more quickly

than the output of U.S. recipients of Chinese

capital rises, aggregate spending and

employment could temporarily fall.


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FUTURE EXPECTATIONS

Challenges:

Banks have a positive foreign asset position;

currency appreciation will be bad

Risks from the loans exposure to the exportsector

Limited capacity to manage currency risk and

deal with currency fluctuations


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free floation of chinese yuan

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