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back to index backCHINAtalk July,  2005

China's Currency Revaluation

What Did the Chinese Government Actually Do?

  • The People's Bank of China (PBOC) announced that China has abandoned its fixed exchange rate with the US dollar and moved to a managed float.
  • This means that, each trading day, the PBOC will set the value of the Chinese renminbi, with a basket of major trading-partner currencies as a guide (including the US dollar, yen, and euro at a minimum).
  • Beijing has not revealed—nor is it likely to anytime soon—the composition of this basket.
  • Bottom line: China has given itself a little more flexibility on its currency than before.
  • Big question: how much more will the renminbi appreciate?

Why Did They Do It Now?

  • China's currency move was in reaction to both external and internal pressures.
  • Part of the government's motive was to head off protectionist moves by the US Congress.
  • But Chinese authorities are also trying to stem the flow of hot money, which has produced a boom in capital investment and pushed its share of the economy from 40% three years ago to 51% last year.

Impacts: Very Small, Unless the Chinese Currency Continues to Appreciate

  • So far, the renminbi has appreciated 2%. This will have almost no impact on the US and Chinese economies.
  • Global Insight's best guess is that Beijing will allow the currency to appreciate by no more than 10% over the next two years. This should be seen in the context of estimates suggesting that the renminbi is undervalued by 30–40%.
  • Assuming that all other Asian economies (including Japan) allow their currencies to appreciate by roughly the same amount, this will translate into a 4% drop in the US dollar on a trade-weighted basis. This is relatively small compared with its 17% drop since early 2002.
  • Another factor to consider is that China's chronic current-account surplus is mainly driven by structural, excess saving in its private sector, rather than a undervalued currency.
  • Bottom line: unless the renminbi appreciates a lot, the overall impact on the US and Chinese economies will be small.
Source: Global Insight - GAI

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