Is the Chinese Renminbi Undervalued Essay Example for Free

Is the Chinese Renminbi Undervalued EssaySince July 2005, first time being revalued afterwards 11 years of fixing at 8.27, Chinese kwai has been heading towards wholly one educational activity all the way from 8.27 to 6.27. Although kwai is a highly regulated silver by g all overnment, Chinese officials could no longer peg the Yuan as it used to be in a closed miserliness because WTO had opened up doors for Chinese manufacturers in 2001 to export cheap goods and services to developed countries. With trillions of foreign bang-up flooding into the country, Yuan has appreciated over 30% over seven years. However, this one-way money go down cannot be sustained. Though it is not sure whether Yuan is at the absolute equilibrium, it is currently neither importantly undervalued nor overvalued. This essay is going to explain why Yuan is modestly priced with analysis in both the basic principle and money flows.Needs for appreciation in pastIn theory, two open economies should ha ve akin purchasing power that is, if 10 units of foreign currency can buy something that is valued at 1 unit of domestic currency, the implied equilibrium exchange rate should also be 10(domestic as based money). Otherwise, in that respect is an arbitrage opportunity. We call this Purchase Power Parity. In reality, despite some limitations round this theory, it explains most of the evaluation problem in China. Take a look at Chinas Balance of Payments over 2003-2010 and it is obvious to observe huge surplus annually in both current and capital fiscal account, accumulating to a foreign reserve of $3.3 trillion.Reach equilibrium?At the government level, on one hand, it had to affix money base to maintain exchange rate against USD at a gradual appreciation pace. On the other hand, it needs to hold huge foreign assets, primarily in USD, to back up its currency from deprecation in the event of capital outflows. Amid the money inflow, Chinese central bank faced mounting pressure o f inflation on local assets. The private sectors are impacted in two ways. Firstly, Chinese residents and companies feel much richer now because higher RMB increases their purchase power of foreign assets. This kernel more imports and capital account outflows. Secondly, inflation and appreciation means that Chinese products and services are more expensive. And this would lead to less(prenominal) exports.Pew Survey showed that 70% of Chinese people feel financially better off than 5 years ago, which among the best in the world. In the last a few years, the fact of continues Yuan appreciation, associated with stories about how China is cash rich and how Chinese investors are buying everything they can in the world, raises interesting intervention if Yuan had appreciated enough. There is also a trend that more goods are manufactured in new WTO members such as Nepal and Vietnam that have price advantage over China. Moreover, in the currency transport market, investors have priced i n modest depreciation for Yuan in the next 12 months and spot market is no longer moving towards one direction.Data showsAll those various observations reveal the same surgical process that drives RMB exchange rate to an equilibrium level. Recent data also suggests that at current FX level, the rise in trade surplus and capital finance account surplus slowed (see chart below). So does foreign reserve.What does it means? If we apply a popular formulaCapital out flow = Foreign Reserve FDI bargain surplus Numbers imply that 62.4 128.5 145.8 = 211.9 billions has flown out of China in the first three quarters of 2012.Although this mind still lacks of actual evidence, the scale of growth slowing down in foreign reserve in 2012 is worth attention since it is so large that it is hard to be justified by seasonal accommodation or calculation period discrepancy. This might signal the start of reverse capital flows of Yuan, which means Yuan is no longer undervalued.UltimatelyThe answer to Yuans valuation problem is complex oddly given that it is still mostly controlled by government and there are so many propelling factors to consider. So far there are some money flows and data support the conclusion that Yuan is no longer significantly undervalued. In the long run, as expectation of Chinese government to forget a fully conversion Yuan is built on, maybe the real answer can only be found out by then.