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The discussion on a Chinese government exchange rate policy of the Yuan and its impacts to the US economy and the hedging solution What have been the exchange rate policies of the Yuan (CNY) or Renminbi (RMB) of the Chinese Government? Let’s start with the reviewing of the exchange rates separately throughout history. There are not a lot of readers may know that the exchange rate of USD/CNY was approximately close to one time at the beginning of the 1980s.
In 1983, two years before I was born, one US Dollar (USD) was traded at 1. 43x of the Chinese Yuan or Renminbi (CNY). Prior 1995, it was unnoticeable period for the economic performance of China, the Chinese Yuan had been depreciated for more than 5 times of its initial value in ten years time 1985 – 1995 to the US Dollar. The exchange rate of USD to CNY had climbed sky-high from 1. 5 times in 1984 to more than 8. 5 times in 1995. The most memorable event was the 50% devaluation as end 1993; the local currency lost half of its value overnight.
And what even more exiting was happened after, the Chinese government has pegged the Yuan at around 8. 2 Yuan to one US Dollar for the next decade. The motive behind has been obviously clear to the world, however the questions are how did the Chinese value the Yuan and is it undervalued consistently, very arguable. The following analysis which bases on the general economy statistics would help us to understand the situation better on the business administrative point of view. The China’s real GDP growth rates had kept slowing down rapidly until the beginning of 2000.
Prior to that the Chinese government had done a lot of works to support the economy growth, including the SOEs sector reform, the agricultural sector reform, modernization of the industrial sector and especially the Yuan dramatic depreciation to support the country unique advantage – export. For more than ten years, since 1994 to late 1995, the Chinese have maintained a fixed exchange rate for their currency, the yuan, relative to the dollar. The rate has been pegged at about 8. 28 Yuan to one Dollar for the entire period. This has prolonged and attracted attention as some have voiced concern that holding down the value of the Yuan is aking the prices of Chinese exports to the U. S. too cheap. It is pretty clear the Chinese’s strategy of the exchange rate policy which is export-oriented and supporting the country development via new investments from budget & trade surplus as well as foreign capital inflows. It was an obvious success of the Chinese as new China has become the world “Porsche” of growth. But, did they have any alternative but the fixed exchange rate policy? In order to maintain the fixed exchange rate, the China’s Central Bank has had to participate in the foreign exchange market actively.
It had controlled the supply and demand of Dollar denominated assets by pumping out or withdrawing back the money supply of Yuan on the market to keep its balance. It could’ve been a double blade if the China national budget had not been strong enough, fortunately it was. Thanks to the huge trade surplus, especially with the US, every, the China has accumulated a giant amount of foreign reserve which has reached 1 trillion US Dollar in 2006 while it was one tenth ten years ago (table 1). During the time, the government budget deficit had also been kept below 2%, it began to be positive in 2008 (chart 2).
As a result of strong reserve, more government spending, rapid expansion of the economy tended to multiple its money supply too; the broader money in circulation continues to grow very rapidly by adding more leverage to the economy as well as maintain high velocity of the money. (Chart 5) the M2 growth YOY has been staying above 15% for a decade before peaking up in 2008, the Chinese government had stepped up in 2003 to sterilize the reserve accumulation by issuing first time its central bank’s paper, however the pace didn’t stop for so long as we saw.
It was indeed a progress of mixed policies which are all focused on growth via export, hence the exchange rate policy turned out to be very key element which can not be replaced. Leaving the good side, what we want to know next is the impact on the United States; is its economy really hurt that demands a violent voice to the international community in relation with China. (Table 2) The US net deficit to China had been increasing rapidly over years. The net deficit to US GDP was 0. 4% in 2000, when it seemed to be small, but increased to 1. 73% in just 6 years later. Generally, the imports from China were mainly low-skilled labor to assemble and process imported parts and materials originated in the Asian countries area that have traditionally exported directly to the U. S. Consequently, the share of U. S. imports from these other countries has reduced dramatically just as China’s share has become domination; whilst the US exports haven’t done so well to China as well as the neighbor region.
In the other word, the impacts of China low-cost exports were severe directly and indirectly. Obviously, the US is not happy with the situation while the flag isn’t in their hand. So, will the Yuan appreciation in near future solve the problem; would it make the U. S. goods exporting to China less expensive and it would it make U. S. good importing from China more 1 The Financial Engineering Subject Assignment Lecturer: Prof. Dr. Markus Freiburghaus Vo Tran Dinh Hieu – EMFB 5 Topic B: Hedging Currency Risk xpensive. Fortunately, we have had a nice precedent in 2006, when the Yuan appreciated more than 15%. The consequence was very encouraging to US as the balance to China trade has shown deceleration, even though it is still deeply negative. It is also very important to emphasize that China still has had significant capital controls recently (especially after 2006), the policy which allows for more inflows than outflows, thus bolstering foreign exchange reserves.
China is gradually loosening some controls (on securities rather than debt), and outflows are likely to grow as new channels develop for Chinese to seek diversification and better returns than those offered by low domestic interest rates (Chart 3: the China 1 year government bill dropped to below the US comparable rate since early of 2008, the spread has even been widen un 2010); the boom and burst of the equity and property markets are examples.
At the bottom line, I think the Chinese has lessened its support to the Yuan gradually since 2006 via various methods, unless the US keeps deteriorating unexpectedly fast, the pressure on Yuan will be reduced. On the other hand, China is also losing its competitive advantage of the labor market to other Asia Pacific countries. In the other word, they hate to concede against the US criticism but somehow are admitting it internally. Moving to the case of the Vietnamese exporter, who has partial expenses, material to be exact, in Yuan and revenue in USD.
Because of the nature of textile industry, specifically in Vietnam, we would estimate that the material costs would account for at least 70% of total expenses. So hedging against the appreciation of RMB relative to USD is more important than the movement of local currency, which is also technically pegged to USD. Based on the aforementioned findings, I propose the following solutions. Firstly, we should think about the operational diversification as it is possible to diversify the material suppliers away from China to avoid the appreciation of Yuan.
In fact, many companies in Viet Nam have done so, they have shifted the import goods from China to other countries like India (for textile, motorbike, car …), ASEANs or the South America countries. This is the cheapest solution and also most effective one because it avoids the complexity of financial hedging method. Second, still operational, we can immediately convert all the USD revenue into RMB and deposit at Chinese bank’s accounts; this will secure the cash flow position in RMB for the next purchase of material or profit transfer back to Vietnam.
And may be at last, we can use various financial hedge tools or so-called the derivatives. On the goods side, we can buy forward the RMB domestically for future usage and sell forward the USD revenue to avoid its potential depreciation against RMB. For the taxpurpose, we all can use the Exchange Traded Notes of USD tied to foreign currency (RMB in this case) to materialize the financial gains from RMB appreciation as a provisions reserve for the increasing in material costs for the same reason.
Table 1: China’s Financial Indicators, 2000-09 Notes: NA = Not available. *USCBC calculations. **People’s Bank of China (PBOC) rate on the last day of the year. Sources: China Statistical Yearbook 2009; NBS website; PBOC Main indicators M0 supply % growth* M1 supply % growth* M2 supply % growth* Exchange rate (RMB/$)* Foreign exchange reserves ($ billion) Foreign debt ($ billion) 2000 1,465 8. 9 5,314 16. 0 12. 3 8. 28 165. 6 145. 7 2001 1,568 7. 1 5,987 12. 7 17. 6 8. 28 212. 2 170. 1 2002 1,727 10. 7,088 16. 8 16. 8 8. 28 286. 4 171. 4 2003 1,974 14. 3 8,411 18. 7 19. 6 8. 28 403. 3 193. 6 2004 2,146 8. 7 13. 6 14. 7 8. 28 609. 9 228. 6 2005 2,403. 11. 9 11. 8 17. 6 8. 07 281. 0 2006 2,707 12. 7 12,603 17. 5 34,560 15. 7 7. 81 323. 0 2007 3,037 12. 2 15,256 21. 0 40,344 16. 7 7. 30 373. 6 2008 3,421 12. 7 16,621 9. 0 47,516 17. 8 6. 83 374. 7 2009 3,824 11. 8 22,000 32. 4 60,600 27. 7 6. 83 2,399. 2 NA 9,597 10,727 13,461 15,830 18,500 22,122 25,410 29,875 818. 8 1,066. 3 1,528. 2 1,946. 0
Table 2: China’s Trade with the United States ($ billion) Notes: US exports reported on FOB basis; imports on a general customs value, CIF basis Source: US International Trade Commission 2000 US exports % change US imports % change Total % change US balance 16. 3 24. 4 100. 0 22. 3 116. 3 22. 6 -83. 7 2001 19. 2 18. 3 102. 3 2. 2 121. 5 21. 4 -83. 0 2002 22. 1 15. 1 125. 2 22. 4 147. 3 21. 2 -103. 1 2003 28. 4 28. 5 152. 4 21. 7 180. 8 22. 8 -124. 0 2004 34. 7 22. 2 196. 7 29. 1 231. 4 28 -162. 0 2005 41. 8 20. 6 243. 5 23. 8 285. 3 23. 3 -201. 6 2006 55. 2 32. 1 287. 8 18. 343 20. 2 -232. 5 2007 65. 2 18. 1 321. 5 11. 7 386. 7 12. 7 -256. 3 2008 71. 5 9. 5 337. 8 5. 1 409. 2 5. 8 -266. 3 2009 69. 6 -2. 6 296. 4 -12. 3 366. 0 -10. 6 -226. 8 2 The Financial Engineering Subject Assignment Lecturer: Prof. Dr. Markus Freiburghaus Chart 1: The USD / CNY official exchange rate Source: Bloomberg; Unit: Chinese Yuan to one US Dollar 10 9 8 7 6 5 4 3 2 1 CN GDP CN CPI Vo Tran Dinh Hieu – EMFB 5 Topic B: Hedging Currency Risk Chart 2: China & US statistics on real GDP & CPI growth Source: Bloomberg; Unit: % YOY 16 US GDP US CPI 14 12 10 8 6 4 2 0 4 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 US CN 0 84 86 88 19 19 19 95 97 99 19 19 19 05 20 09 20 19 -2 -4 Chart 3: One year treasury bill rate of US and CN Source: Bloomberg; Unit: % per annum 7 US rate CN rate Chart 4: Government budget surplus/deficit versus GDP Source: Bloomberg Unit: % 4 2 0 1999 -2 -4 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 6 5 4 3 -6 2 -8 1 -10 0 2004 2005 2006 2007 2008 2009 2010 -12 Chart 5: Money supply (M2) growth Source: Bloomberg Unit: % YOY 30 US CN 25 20 15 10 5 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Notes and reference: Raw data are collected from the Bloomberg Professional Service, which is available at my job. Based on that, the views expressed and developed in the article are personally of my own. References are used moderately from various online resources such as: news providers (Bloomberg, Reuters, WallStreet Journal… ), statistics bureaus and official website of China and US governments. The article is written on the discussing manor and does not specify detail references as well as disclaimers. 3