Description
Link China’s exchange rate policy with its development strategy.
?
?
?
?
On July 21, 2005, China revalued its decade long quasi-fixed exchange rate of 8.28 Yuan per USD by 2.1% to 8.11, and at the same time, introduced a more market based exchange rate system The change was considered too small Trade surplus was at record high; had trade frictions with EU and Japan The tightly managed exchange rate put strain on the china’s economy
?
?
Link China’s exchange rate policy with its development strategy. Discuss the historical context and sustainability of flaws with China’s development strategy Understand the mechanics of China’s exchange rate policy. Specifically, discuss the role of capital controls and sterilization to the policy , as well as challenges, risks and benefits of maintaining a quasi-fixed exchange rate against the USD. In addition, highlight the importance of sequencing of exchange rate reform with banking sector and capital controls reform
?
Debate what China should do with its exchange rate policy and how this will impact businesses located in China and elsewhere
?
? ?
What was China’s development strategy between 1978 and 2005? Let me read out two quotes: In response to the 2003 lifting of quotas, Esquel group Chairperson Marjorie Yang commented that Esquel group was “introducing better supply chain management and better systems generally. I’ve no doubt we’ll be able to take on our competitors and bust ass”
?
?
Chinese Communist party proposal on the 11th 5 year programme:
Comrades in the whole party and people of all ethnic groups across the nation should rally closely around the party central committee with Comrade Hu Jintao as General secretary; hold aloft the great banner of marxism-leninism, Mao Zedong thought, Deng Xiaoping theory and the important thinking of the three representations; uphold the party’s basic line, programme and experience; comprehensively implement a scientific development concept; work enthusiastically and in a down to earth manner; forge ahead with a keen determination……..
?
?
?
?
?
Yang (a Hong Kong native with strong roots in mainland china) is very entrepreneurial and capitalist The case emphasizes the dynamic nature of china’s economy Despite all the major reforms China continues to be a communist country China is still in a transition to a market economy What is a “socialist-market economy”?
?
? ?
? ?
In summary, the Chinese reallocated resources and became more capitalist How did they do this? Historically, they moved slowly through a gradualist, experimental approach The focus was initially on domestic growth Components of development strategy can be divided into “plan elements” and “market elements”
? ? ? ? ? ?
Market elements Initiatives/reward Quasi property Prices TVE FDI allowed
? ?
? ? ? ?
Plan elements Interventions in all areas of the economy SOEs not allowed to fail Property unclear in many areas FDI restrictions Capital controls
?
?
?
In the 90s the Chinese channeled resources from savings, FDI, surplus labor etc The restructuring process also involved restructuring SOEs and letting some fail as well as transforming the banks An important component of development strategy was undervalued exchange rate, which made Chinese products cheap for foreigners, leading to export driven growth
?
? ?
?
Bringing in FDI was considered an appropriate way to fund the mercantile development strategy, since the banking sector and capital market was not effective in capital allocation Strategy was supported because of excess labor supply This strategy required China to finance US imports of Chinese products through an undervalued exchange rate Given the track record it appears that the strategy was successful
? ?
? ? ?
Prasad and Wei argue against this explanation: The facts do not support it. Most of the FDI flows into China have come from countries exporting to China, not importing China chose not to devalue in 1997-98 even though it would increased exports Massive build up of reserves is a relatively recent phenomenon For much of the past two decades up to 2001, the chinese currency was likely to be overvalued not undervalued according to the black market premium
?
?
Rapid export growth indicates Yuan undervaluation. But imports are growing as fast (at 35% p.a. for the last four years). However, in first half of 2005 the increase in imports (14%) was much lower than increase in exports (34%), indicating expectations of appreciation Loss in the value of yuan against major currencies between 2001 and 2005 indicates Yuan undervaluation. But some economists noted that the dramatic increase in the Yuan’s value between 1994 and 2001 (see Ex 1b) was only slightly offset by inflation differentials against China’s trading partners since 2001
?
?
China’s rapid forex reserve accumulation represents Yuan undervaluation. But this could be due to short term speculative flows, which bear little relation to economic fundamentals Faster labor productivity growth in China relative to its trade partners was the fundamental force putting upward pressure on the Renminbi (Ex 13)
?
?
Comprehensive studies supported the view of an undervalued Yuan. One study noted that prices were not in line with incomes. China’s actual price level was 0.23 of the US price level; expected price level was 0.36 implying an undervaluation of 35% Apparent circumvention of capital controls favoring Yuan over dollar assets indicates Yuan undervaluation. Examples included apparent fall in imports, net errors and omissions turning positive, and bank repatriation turning positive
?
?
?
If you think it is undervalued, how is it being kept undervalued? After the Asian Financial crisis growing capital flows to China put pressure on Yuan to appreciate. In order to prevent this: A) The central bank intervened: China’s central bank intervened by exchanging incoming dollars for Renminbi at the Yuan exchange rate. The central bank used this to buy US Treasuries. The release of Renminbi threatened to fuel inflation and to overheat the economy
?
China counteracted much of this pressure through sterilization, under which loans to banks were reduced, reserve requirements were increased, and Yuan denominated bonds were issued to absorb liquidity and keep the monetary base from expanding. The central bank issued paper amounting to 87b in 2003, 182b in 2004 and 89b in the first quarter of 2005. The sterilization bonds offset only half of the increase in reserves between 2003 and 2005; the remainder of the increase in reserves contributed to money growth
?
?
State owned banks were required to purchase these low yielding securities; weakened bank balance sheets; threatened financial stability B) Capital controls were used: Government tightened controls on inflows and loosened controls on outflows
?
?
?
?
What is the role of Capital Controls? How are they supposed to help? Allowing appreciation in the real exchange rate would hurt exports Alternatively, reducing interest rates would intensify inflationary risks Policy makers face a difficult trade off among 3 policy objectives: monetary policy autonomy, stable exchange rate and free capital mobility
?
Only 2 of these 3 objectives can be reached simultaneously
? ?
?
?
In practice, are currency controls effective? Interest rates on shore were higher than off shore There are lots of evidence that controls were porous There are some appreciation up to 2001 (Ex 1b) and depreciation thereafter
? ?
? ? ?
?
Are capital controls designed to help with the market element or plan element? Market elements include the fact that controls helped decrease appreciation, which helped increase exports In addition, higher interest rates helped to keep down inflation. These factors helped growth Plan elements included helping to control expansion of credit, helping to control expansion of banks, and helping to allocate credit, which helped with control It is not clear which element was dominant
?
?
?
What do you think of the buildup of reserves? What are the problems associated with holding too many reserves? What are the costs of this strategy? After the Asian financial crisis of 1997-98 holding high levels of reserves was considered appropriate China’s reserves would be sufficient to recapitalize the entire banking system
?
?
Given China’s large holdings of USD reserves, a revaluation would imply a significant loss Sterilization is expensive and not fully effective an overheating economy. Money and credit growth in China remains very strong, which is fueled in part by the inadequacies of sterilization. However, abundant labor supply implies that even in a rapidly growing economy, inflationary pressures are modest
?
Reserves earn low returns (US T rates are just 3%) compared to FDI (earns 15%). FDI has other benefits like technology and skills transfer. Perhaps reserves are “collateral” for attracting FDI; FDI inflows have to be offset by reserve outflows and to keep sufficient collateral on hand to match the rising value of FDI, China must run ongoing trade surpluses
?
?
?
?
In addition to reserves what other flaws do you see in China’s strategy? 1) problems with relying on FDI: Strong inflows of FDI reflected inefficiencies in China’s capital markets 2) discrimination between private and public enterprises in accessing bank financing (now not relevant) 3) Foreign firms had greater incentives to invest than domestic firms
?
?
?
?
Rising Inequality: growing divide between rural workers and export sector workers; Firms faced negative real rates of interest i.e. nominal rate less than increase in producer prices; so they substituted labor with capital The economy has to be absorb significant number of laid off workers from the public sector Remember the 2005 riots?
?
?
Weak domestic demand/household consumption: excessive focus on exports can be dangerous Savings are high because there are no international diversification opportunities; usage of credit cards or loans is limited; people put the money in bank deposits
? ?
Weak Banking Sector: Banks were forced to keep NPAs and lend to weak enterprises
?
?
?
The issue of sequencing increased exchange rate flexibility with banking sector reform and capital account liberalization is a crucial issue. A floating rate system needs market institutions- strong banks and liquidity; these are not yet there Is China trying to make some cosmetic changes to appease the international community of pursuing its gradualist approach to reforms
?
?
While Chinese companies are becoming more productive and efficient, they have been blamed for unfair practices (violation of IPRs) China has abundant supply of labor. MNCs can draw on this and decrease the inequality over a period of time
doc_117409504.pptx
Link China’s exchange rate policy with its development strategy.
?
?
?
?
On July 21, 2005, China revalued its decade long quasi-fixed exchange rate of 8.28 Yuan per USD by 2.1% to 8.11, and at the same time, introduced a more market based exchange rate system The change was considered too small Trade surplus was at record high; had trade frictions with EU and Japan The tightly managed exchange rate put strain on the china’s economy
?
?
Link China’s exchange rate policy with its development strategy. Discuss the historical context and sustainability of flaws with China’s development strategy Understand the mechanics of China’s exchange rate policy. Specifically, discuss the role of capital controls and sterilization to the policy , as well as challenges, risks and benefits of maintaining a quasi-fixed exchange rate against the USD. In addition, highlight the importance of sequencing of exchange rate reform with banking sector and capital controls reform
?
Debate what China should do with its exchange rate policy and how this will impact businesses located in China and elsewhere
?
? ?
What was China’s development strategy between 1978 and 2005? Let me read out two quotes: In response to the 2003 lifting of quotas, Esquel group Chairperson Marjorie Yang commented that Esquel group was “introducing better supply chain management and better systems generally. I’ve no doubt we’ll be able to take on our competitors and bust ass”
?
?
Chinese Communist party proposal on the 11th 5 year programme:
Comrades in the whole party and people of all ethnic groups across the nation should rally closely around the party central committee with Comrade Hu Jintao as General secretary; hold aloft the great banner of marxism-leninism, Mao Zedong thought, Deng Xiaoping theory and the important thinking of the three representations; uphold the party’s basic line, programme and experience; comprehensively implement a scientific development concept; work enthusiastically and in a down to earth manner; forge ahead with a keen determination……..
?
?
?
?
?
Yang (a Hong Kong native with strong roots in mainland china) is very entrepreneurial and capitalist The case emphasizes the dynamic nature of china’s economy Despite all the major reforms China continues to be a communist country China is still in a transition to a market economy What is a “socialist-market economy”?
?
? ?
? ?
In summary, the Chinese reallocated resources and became more capitalist How did they do this? Historically, they moved slowly through a gradualist, experimental approach The focus was initially on domestic growth Components of development strategy can be divided into “plan elements” and “market elements”
? ? ? ? ? ?
Market elements Initiatives/reward Quasi property Prices TVE FDI allowed
? ?
? ? ? ?
Plan elements Interventions in all areas of the economy SOEs not allowed to fail Property unclear in many areas FDI restrictions Capital controls
?
?
?
In the 90s the Chinese channeled resources from savings, FDI, surplus labor etc The restructuring process also involved restructuring SOEs and letting some fail as well as transforming the banks An important component of development strategy was undervalued exchange rate, which made Chinese products cheap for foreigners, leading to export driven growth
?
? ?
?
Bringing in FDI was considered an appropriate way to fund the mercantile development strategy, since the banking sector and capital market was not effective in capital allocation Strategy was supported because of excess labor supply This strategy required China to finance US imports of Chinese products through an undervalued exchange rate Given the track record it appears that the strategy was successful
? ?
? ? ?
Prasad and Wei argue against this explanation: The facts do not support it. Most of the FDI flows into China have come from countries exporting to China, not importing China chose not to devalue in 1997-98 even though it would increased exports Massive build up of reserves is a relatively recent phenomenon For much of the past two decades up to 2001, the chinese currency was likely to be overvalued not undervalued according to the black market premium
?
?
Rapid export growth indicates Yuan undervaluation. But imports are growing as fast (at 35% p.a. for the last four years). However, in first half of 2005 the increase in imports (14%) was much lower than increase in exports (34%), indicating expectations of appreciation Loss in the value of yuan against major currencies between 2001 and 2005 indicates Yuan undervaluation. But some economists noted that the dramatic increase in the Yuan’s value between 1994 and 2001 (see Ex 1b) was only slightly offset by inflation differentials against China’s trading partners since 2001
?
?
China’s rapid forex reserve accumulation represents Yuan undervaluation. But this could be due to short term speculative flows, which bear little relation to economic fundamentals Faster labor productivity growth in China relative to its trade partners was the fundamental force putting upward pressure on the Renminbi (Ex 13)
?
?
Comprehensive studies supported the view of an undervalued Yuan. One study noted that prices were not in line with incomes. China’s actual price level was 0.23 of the US price level; expected price level was 0.36 implying an undervaluation of 35% Apparent circumvention of capital controls favoring Yuan over dollar assets indicates Yuan undervaluation. Examples included apparent fall in imports, net errors and omissions turning positive, and bank repatriation turning positive
?
?
?
If you think it is undervalued, how is it being kept undervalued? After the Asian Financial crisis growing capital flows to China put pressure on Yuan to appreciate. In order to prevent this: A) The central bank intervened: China’s central bank intervened by exchanging incoming dollars for Renminbi at the Yuan exchange rate. The central bank used this to buy US Treasuries. The release of Renminbi threatened to fuel inflation and to overheat the economy
?
China counteracted much of this pressure through sterilization, under which loans to banks were reduced, reserve requirements were increased, and Yuan denominated bonds were issued to absorb liquidity and keep the monetary base from expanding. The central bank issued paper amounting to 87b in 2003, 182b in 2004 and 89b in the first quarter of 2005. The sterilization bonds offset only half of the increase in reserves between 2003 and 2005; the remainder of the increase in reserves contributed to money growth
?
?
State owned banks were required to purchase these low yielding securities; weakened bank balance sheets; threatened financial stability B) Capital controls were used: Government tightened controls on inflows and loosened controls on outflows
?
?
?
?
What is the role of Capital Controls? How are they supposed to help? Allowing appreciation in the real exchange rate would hurt exports Alternatively, reducing interest rates would intensify inflationary risks Policy makers face a difficult trade off among 3 policy objectives: monetary policy autonomy, stable exchange rate and free capital mobility
?
Only 2 of these 3 objectives can be reached simultaneously
? ?
?
?
In practice, are currency controls effective? Interest rates on shore were higher than off shore There are lots of evidence that controls were porous There are some appreciation up to 2001 (Ex 1b) and depreciation thereafter
? ?
? ? ?
?
Are capital controls designed to help with the market element or plan element? Market elements include the fact that controls helped decrease appreciation, which helped increase exports In addition, higher interest rates helped to keep down inflation. These factors helped growth Plan elements included helping to control expansion of credit, helping to control expansion of banks, and helping to allocate credit, which helped with control It is not clear which element was dominant
?
?
?
What do you think of the buildup of reserves? What are the problems associated with holding too many reserves? What are the costs of this strategy? After the Asian financial crisis of 1997-98 holding high levels of reserves was considered appropriate China’s reserves would be sufficient to recapitalize the entire banking system
?
?
Given China’s large holdings of USD reserves, a revaluation would imply a significant loss Sterilization is expensive and not fully effective an overheating economy. Money and credit growth in China remains very strong, which is fueled in part by the inadequacies of sterilization. However, abundant labor supply implies that even in a rapidly growing economy, inflationary pressures are modest
?
Reserves earn low returns (US T rates are just 3%) compared to FDI (earns 15%). FDI has other benefits like technology and skills transfer. Perhaps reserves are “collateral” for attracting FDI; FDI inflows have to be offset by reserve outflows and to keep sufficient collateral on hand to match the rising value of FDI, China must run ongoing trade surpluses
?
?
?
?
In addition to reserves what other flaws do you see in China’s strategy? 1) problems with relying on FDI: Strong inflows of FDI reflected inefficiencies in China’s capital markets 2) discrimination between private and public enterprises in accessing bank financing (now not relevant) 3) Foreign firms had greater incentives to invest than domestic firms
?
?
?
?
Rising Inequality: growing divide between rural workers and export sector workers; Firms faced negative real rates of interest i.e. nominal rate less than increase in producer prices; so they substituted labor with capital The economy has to be absorb significant number of laid off workers from the public sector Remember the 2005 riots?
?
?
Weak domestic demand/household consumption: excessive focus on exports can be dangerous Savings are high because there are no international diversification opportunities; usage of credit cards or loans is limited; people put the money in bank deposits
? ?
Weak Banking Sector: Banks were forced to keep NPAs and lend to weak enterprises
?
?
?
The issue of sequencing increased exchange rate flexibility with banking sector reform and capital account liberalization is a crucial issue. A floating rate system needs market institutions- strong banks and liquidity; these are not yet there Is China trying to make some cosmetic changes to appease the international community of pursuing its gradualist approach to reforms
?
?
While Chinese companies are becoming more productive and efficient, they have been blamed for unfair practices (violation of IPRs) China has abundant supply of labor. MNCs can draw on this and decrease the inequality over a period of time
doc_117409504.pptx