The undervaluation of the renminbi : EU point of view

[KrazyHorse]

Originally posted by chegitz guevara
Because if they don't they'll be hauled before the WTO and slapped with tariffs.

It's also costing them a fortune to peg the yuan at an artificially low rate.

[DAVOUT]

Originally posted by DanS
For the life of me, I cannot find that article. Can you cut and paste?

I'm interested.

This is the IMF text :

On October 31, 2003, the International Monetary Fund's (IMF) Executive Board concluded the Article IV consultation with China.1

Background

Over the last few years, China has maintained its strong growth momentum and continued its rapid integration into the global economy. Despite the difficult world economic environment and domestic uncertainties, China's GDP growth has remained above 7½ percent in recent years, supported by appropriate macroeconomic policies and structural reforms. Spurred by accession to the WTO in December 2001, China's exports have expanded rapidly. At the same time, robust domestic demand and further market opening under China's WTO commitments have also led to strong import growth.

Real GDP grew by 8 percent in 2002, underpinned by the strength of exports and fixed investment, which registered growth rates of 22 percent and 17 percent, respectively. In 2003, the outbreak of Severe Acute Respiratory Syndrome (SARS) in the second quarter temporarily dampened GDP growth as activity in the services sector weakened. However, external trade continued to expand rapidly, and the services sector appears to have made a quick rebound. In the first three quarters of 2003, GDP grew by 8½ percent (year-on-year), led by strong fixed investment. Deflationary pressures have been easing. After declining by 0.8 percent in 2002, consumer prices increased by 0.7 percent in the first nine months of 2003. Despite the strong GDP growth, unemployment continues to rise; registered unemployment in the urban areas increased to 4 percent in 2002, up 0.4 percentage points from 2001. The level of surplus labor in the agricultural sector is estimated to be larger, and rural-urban income disparities have continued to widen.

China's overall external position has strengthened further. The current account surplus rose from 1½ percent of GDP in 2001 to 2¾ percent in 2002, mainly on account of increases in the trade surplus and private transfers. The financial account posted another large surplus in 2002, as foreign direct investment (FDI) inflows amounted to $53 billion and there was a repatriation of other capital from abroad. Official reserves increased by $76 billion in 2002. In the first 9 months of 2003, the trade surplus declined sharply as imports surged by 41 percent, while exports grew by 32 percent. However, official reserves rose by $98 billion, reaching $393 billion by end-September (equivalent to around 10½ months of imports). While FDI inflows have remained strong, the pickup in the pace of reserve accumulation in 2003 mostly reflects other capital inflows.

As the economy rebounded from the SARS epidemic, growth has picked up in the second half of 2003 and is now projected to reach 8½ percent for the year. Economic activity should remain strong in 2004, with the economy growing at about an 8 percent annual rate. Prices are expected to post small increases over the next year and one half, as the effects of some increases in commodity and food prices would more than offset downward pressures from supply-side factors, including lower tariffs and ongoing productivity gains. The external current account surplus would decline somewhat, as further WTO-related trade liberalization boosts imports, while export growth would slow down from the very high rates recorded over the last year. Sizable net capital inflows, including FDI, are likely to continue, and the external position is expected to remain strong.

With regard to structural reforms, in the banking sector, stricter prudential regulations and improving lending practices have contributed to a decline in the reported ratio of nonperforming loans to total loans, and asset management companies have made progress in recovering distressed assets. In the state-owned enterprise (SOE) sector, the government has continued to introduce shareholding and modern management systems into large SOEs, while exiting from the smaller enterprises. Since 1997, more than 27 million workers have been laid off as a result of closing of loss-making SOEs and reduction of redundant employees. To mitigate the social impact of reforms, the authorities have taken steps to strengthen the social safety net, including by increasing pension payments, widening coverage of the unemployment insurance and urban minimum living allowance assurance schemes, and providing assistance to laid-off workers for finding new employment.

Executive Board Assessment

Executive Directors commended the Chinese authorities for the economy's impressive output growth and further integration with the global economy. While near-term economic prospects generally remain favorable, Directors cautioned that continued strong investment activity and rapid money and credit growth could lead to a buildup of imbalances in some sectors of the economy. Directors also emphasized that medium-term prospects depend critically on the pace of structural reforms, especially for the banking system, the state-owned enterprises (SOEs), and labor markets.

Directors welcomed the measures the authorities have taken to curb growth of monetary and credit aggregates and, in particular, lending to the real estate sector. However, Directors called for stronger action to rein in excessive credit growth and curb potential overinvestment in some sectors of the economy. Continued strong credit growth could affect the overall quality of the loan portfolio of state banks, adding to the nonperforming loan problems these institutions already face.

Most Directors noted that there is no clear evidence that the renminbi is substantially undervalued at this juncture. Directors also felt that a currency revaluation would not by itself have a major impact on global current account imbalances—particularly given China's relatively small share in world trade. Nevertheless, Directors considered that the rapid build-up of foreign exchange reserves indicates some pressure on the exchange rate and imposes costs on the Chinese economy, especially difficulties in preventing excessive monetary expansion. In this context, Directors observed that increased flexibility of the exchange rate over time would be in the best interest of China. In particular, it would allow more room to pursue an independent monetary policy, help cushion China's economy against adverse shocks, and facilitate adjustment to the major structural reforms that are underway. Directors considered that China could, in a phased manner, introduce more flexibility to its exchange rate without causing major disruptions to its economy. Most Directors stressed that a move toward flexibility should be carefully planned and sequenced with ongoing structural reforms that are crucial to its success, and emphasized the need to move speedily with these reforms. They felt that the timing of a shift toward greater exchange rate flexibility should be left to the authorities to decide. A number of Directors, however, felt that the authorities should take advantage of the present circumstances to take quickly an initial step toward greater exchange rate flexibility. Directors underscored the need to improve the functioning of the foreign exchange market by eliminating trading restrictions and surrender requirements, widening the base of participants, and developing instruments for foreign exchange risk management.

Directors supported the authorities' gradual approach to capital account liberalization, observing that a key prerequisite for liberalization is a well-capitalized and sound banking system. They welcomed the implementation of the Qualified Foreign Institutional Investor scheme, and considered that the strong external position provided the right environment for the launching of the Qualified Domestic Institutional Investor scheme and other initiatives aimed at removing some of the restrictions on overseas investment by Chinese residents. Directors noted, however, that while these initiatives are useful, they will not have a substantial impact on capital flows in the short run, and they would not be effective substitutes for moving toward greater exchange rate flexibility.

Directors cautioned that the medium- and longer-term fiscal outlook remains a source of vulnerability. They pointed to the substantial future demands that may be placed on the budget to meet quasi-fiscal liabilities in the financial sector and the pension system, the costs of restructuring SOEs, and increased demands for social services—in part associated with an aging population. Against this background, Directors welcomed the good prospects for meeting the authorities' target for this year's fiscal deficit. Given a likely over-performance on revenues, Directors urged the authorities to stick to budgeted levels for spending and to use the additional revenue to reduce tax refunds owed to exporters and to further consolidate the fiscal position. Directors welcomed the authorities' intention to keep the level of the fiscal deficit roughly unchanged in nominal terms over the next few years, which will imply a declining trend in the deficit relative to GDP. In addition, they supported the authorities' efforts to establish a framework of three-year rolling fiscal forecasts that will set fiscal policy in a medium-term context.

Directors emphasized that a number of important reforms will provide crucial support to fiscal adjustment. They supported the ongoing efforts to improve tax administration and the tax structure, including shifting VAT from a production to a consumption base and extending it to services. They underscored the importance of allowing for rising social expenditure needs and of improvements in public expenditure management through better prioritization. Directors noted that these reforms would have implications for lower levels of government, and stressed that local governments should have sufficient fiscal resources to carry out their responsibilities. In this context, Directors supported a more comprehensive reform of center-local fiscal relations, including improved reporting by the provinces. They also encouraged a stronger effort to improve fiscal transparency, especially regarding quasi-fiscal liabilities and off-budget activities.

While recognizing that progress has been made on financial sector reform, including the establishment of the new China Banking Regulatory Commission, Directors stressed that much remains to be done to establish a sound and competitive banking system. They looked forward to the development of a comprehensive reform plan for state-owned banks. They also stressed the need to continue to reduce the large stock of non-performing loans and curb the flow of new ones. This will require a strengthened regulatory regime, including an improved legal framework for creditor rights, foreclosures, and bankruptcy procedures. Directors encouraged the authorities to reduce the tax burden on financial institutions, including through the allowance of full deductibility for loan-loss provisions and a shift in the business tax from a gross-interest to a net-interest basis. Moving ahead expeditiously to liberalize lending rates was also generally supported, as it would help banks increase their commercial orientation by learning to price risk appropriately. Directors welcomed the authorities' intention to provide additional capital injections in the state-owned commercial banks only when the banks have demonstrated substantial improvements in performance and governance, and recommended that such decisions be made in the context of clear plans regarding the future ownership structure of the state-owned banks.

Directors commended the start of work on a self-assessment of the financial sector. They recommended that China participate soon in the Financial Sector Assessment Program, as this could help in formulating the next steps in financial sector reform. Directors welcomed the recent implementation of the Anti-Money Laundering Administrative Rules for financial institutions and encouraged the authorities to continue with their efforts to improve the regime for combating terrorism financing.

Directors underscored the importance of pushing forward with the reform of the SOEs, including changes in the ownership structure. They welcomed the establishment of the State Asset Supervision and Administration Commission of the State Council, and urged the authorities to establish transparent procedures and the market infrastructure for the sale of assets to ensure that the state receives fair value. Directors also supported continued efforts to enforce hard budget constraints and effectively deal with loss-making SOEs in a timely fashion, establish modern enterprise management systems, improve the incentive system for senior managers, relieve enterprises of their social responsibilities, and increase competition by, inter alia, breaking up large state utilities and monopolies.

Directors considered rising unemployment and the widening gap between rural and urban incomes to be pressing problems. They stressed the importance of addressing the employment and social aspects of the reform process, and of strengthening the safety net to mitigate the social costs of reforms. In this regard, they welcomed the reduction of obstacles for rural migrants to work in urban areas and increased payments to laid-off SOE workers, and recommended further reform to allow freer movement of labor. Job growth in the private sector could be stimulated by improved access to financing and reduced barriers to entry into new lines of business. Directors also encouraged the Chinese authorities to revise key parameters of the current pension system to ensure long-term viability and minimize contingent liabilities.

Directors noted that trade reforms, including those implemented as part of WTO accession, have contributed to the rapid expansion in China's external trade. They encouraged the authorities to continue to implement WTO commitments, including market openings in banking, insurance, and retailing. Directors expressed appreciation for China's provision of debt relief in line with the HIPC Initiative.

Directors commended the improvements that have been made in the compilation and timely provision of economic statistics. They urged the authorities to make further improvements, including providing annual and quarterly real GDP data on an expenditure basis; reporting data on the international investment position as soon as feasible; presenting the fiscal accounts on a standard government finance statistics basis; and compiling labor market data in a manner consistent with international guidelines. In this regard, they welcomed China's recent subscription to the Fund's General Data Dissemination Standard and its intention to join the Special Data Dissemination System in the future.

[DAVOUT]

Originally posted by Kidicious


First of all the Chinese Central Bank does not have the power to maintain a peg without buying dollars. That fact stands alone by the fact that Chinese currency exists outside of China.

You never recover from your missing the first five minutes of the foreign exchange course; the teacher said : a non convertible currency cannot be used in foreign transactions.

This is why you cannot answer the question regarding the payment of the dollars supposedly bought.

[Kidlicious]

Originally posted by DAVOUT


You never recover from your missing the first five minutes of the foreign exchange course; the teacher said : a non convertible currency cannot be used in foreign transactions.

This is why you cannot answer the question regarding the payment of the dollars supposedly bought.

That's because I can buy and sell Chinese currency here in the US.

The dollars are paid for in remnimbi. That's what a currency exchange is.

[Kidlicious]

Wasn't looking, but I just happen to run across this.

Made in China

Due to its trade surplus with the United States, and its currency's peg to the U.S. greenback, China has been a steady buyer of dollar-denominated assets.

I hope we can lay this matter to rest now.

[Kidlicious]

DAVOUT,

What does all this matter anyway? The point is that the Chinese peg the dollar and this results in them retaining dollars. Even if what you were saying were possible and true, who cares? The result is the same. That is that the weaker they maintain the currency peg to the dollar the more dollars they retain.

[DAVOUT]

Originally posted by Kidicious
DAVOUT,

What does all this matter anyway? The point is that the Chinese peg the dollar and this results in them retaining dollars. Even if what you were saying were possible and true, who cares? The result is the same. That is that the weaker they maintain the currency peg to the dollar the more dollars they retain.

Everybody interested in the subject cares (and commercial relations with China will interest more and more millions of people soon) :
- China has excess dollars only because they have a positive trade balance which is currently shrinking because of their considerable imports, and a flow of foreign investments; this is not guaranteed for the future; on long period the Chinese foreign trade is likely to be comfortably balanced. The US foreign deficit is with the whole world, and we see no trend toward its reduction.
- There is a huge difference between converting dollars earned through trade in dollar assets (Treasury bonds) and buying dollars on the market. The later is in the realm of speculation (generally accelerating dramatically a trend), and the former is made through much more controlable channels, and has only an indirect effect over time on the value of the dollar. But both result in strengthening the dollar, that is indirectly strengthening the yuan.
- Accordingly, we can safely anticipate that any significant change in the peg rate will be the consequence of a huge variation of the dollar, until the Chinese economy has an internal need for a change.

[Kidlicious]

Originally posted by DAVOUT
- There is a huge difference between converting dollars earned through trade in dollar assets (Treasury bonds) and buying dollars on the market. The later is in the realm of speculation (generally accelerating dramatically a trend), and the former is made through much more controlable channels, and has only an indirect effect over time on the value of the dollar.

Buying dollars does contribute to earning them through trade. The yuan are used to buy Chinese imports and to invest in China. The more dollars they buy the more they will export to the US.

Originally posted by DAVOUT
But both result in strengthening the dollar, that is indirectly strengthening the yuan.

Huh? How does this strengthen the yuan?

[DAVOUT]

Originally posted by Kidicious

Buying dollars does contribute to earning them through trade. The yuan are used to buy Chinese imports and to invest in China. The more dollars they buy the more they will export to the US.


Huh? How does this strengthen the yuan?

Even after a sympathetic effort, I am obliged to tell you that your first paragraph has no meaning whatsoever.

A currency is said to become stronger, compared to other currencies, when you need less of it than you needed before for buying a given quantity of other currencies.

In the particular case of the yuan/dollar, about 2 years ago, you needed one dollar to buy one Euro, and correlatively you needed 8,28 yuans for one Euro. When the dollar later increased in value, you needed only 0,8 dollar for one Euro, and corrrelatively you needed only 6.62 yuans. The relationship between the yuan and the dollar remained the same which resulted in a strenthening of the yuan.

[Kidlicious]

Originally posted by DAVOUT
Even after a sympathetic effort, I am obliged to tell you that your first paragraph has no meaning whatsoever.

It's similar to the central bank buying bonds to increase the liquidity in the domestic economy. Buying foreign currency with your currency increases your exports and FDI the same way that your central bank uses monetary policy to increase domestic spending and investment.

Originally posted by DAVOUT
A currency is said to become stronger, compared to other currencies, when you need less of it than you needed before for buying a given quantity of other currencies.

In the particular case of the yuan/dollar, about 2 years ago, you needed one dollar to buy one Euro, and correlatively you needed 8,28 yuans for one Euro. When the dollar later increased in value, you needed only 0,8 dollar for one Euro, and corrrelatively you needed only 6.62 yuans. The relationship between the yuan and the dollar remained the same which resulted in a strethening of the yuan.

The yuan would strengthen if it were not for the peg. The peg prevents it from strengthening. The whole deal does nothing but weaken both currencies. Because of it the Chinese have to invest so much in the US economy that other investment is discourage, hence the weak dollar.

[DAVOUT]

I sincerely believe that you should write your complete theory on the peg. I am not sure the Chinese would be interested, but the Nobel jury ... hehe ...

[Kidlicious]

Originally posted by DAVOUT
I sincerely believe that you should write your complete theory on the peg.

It's not my theory. You're the one with your own theory. I'm waiting for you to tell us how it jives with the fundamentals of economics.

[DAVOUT]

Originally posted by Kidicious



The yuan would strengthen if it were not for the peg. The peg prevents it from strengthening. The whole deal does nothing but weaken both currencies.

Terribly wrong.

Regarding a more recent period than the one I was referring to, and during which the dollar weakened, please read the following :.


Excerpt of IMF Global financial stability report – September 2002. (2nd quarter)

…. Three Asian economies – China, Hong Kong SAR, and Malaysia- have exchange rates pegged to the U.S. dollar. Their currency automatically weakened as the dollar fell, helping improve their competitiveness vis-à-vis other economies in the region. …..

You will notice that the pegged currencies follow AUTOMATICALLY, the variations of the dollar.

I am note sure you are interested in learning what a pegged currency really is, but if you are, you could read at this address:

http://www.imf.org/external/pubs/ft/wp/2003/wp03160.pdf

an IMF paper on Exchange Rate Regime detailing all possible arrangements.

[Tripledoc]

Is there a co-relation between military power and currency standing? Meaning that the stronger currency the weaker the military power. So military power is inversely proportional to the value of the currency. If so that would suggest that a weak currency is actually a sign of increasing miltarism.

[Main_Brain]

Weak Currency favours (Industrial/Economic ) Growth due to making Exports of said Country more Attractive to the Rest of the World. I cannot really relate this to the Military because I lack the Data.