Is the Chinese Renminbi Undervalued Essay Example for Free

Is the Chinese Renminbi Undervalued EssaySince July 2005, first time being revalued after 11 historic period of fixing at 8.27, Chinese Yuan has been heading towards only one direction all the way from 8.27 to 6.27. Although Yuan is a highly set currency by g everyplacenment, Chinese officials could no longer peg the Yuan as it used to be in a closed economy because WTO had opened up doors for Chinese manufacturers in 2001 to export cheap goods and service to developed countries. With trillions of foreign capital flooding into the country, Yuan has appreciated over 30% over seven years. However, this one-way money flow cannot be sustained. Though it is not sure whether Yuan is at the absolute equilibrium, it is currently neither significantly undervalued nor overvalued. This act is going to explain why Yuan is modestly priced with analysis in both the fundamentals and money flows.Needs for appreciation in pastIn theory, two open economies should have equivalent purchasing p ower that is, if 10 building blocks of foreign currency can buy something that is valued at 1 unit of domestic currency, the implied equilibrium central rate should also be 10(domestic as based money). Otherwise, there is an arbitrage opportunity. We call this Purchase Power Parity. In reality, notwithstanding some limitations about this theory, it explains most of the valuation problem in China. Take a look at Chinas Balance of Payments over 2003-2010 and it is translucent to observe huge intemperance annually in both current and capital financial account, accumulating to a foreign reserve of $3.3 trillion.Reach equilibrium?At the government level, on one hand, it had to increase money base to maintain exchange rate against USD at a gradual appreciation pace. On the former(a) 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 pressur e of inflation on local assets. The private sectors are impacted in two ways. Firstly, Chinese residents and companies smell much richer now because higher RMB increases their purchase power of foreign assets. This means 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 exports.Pew Survey showed that 70% of Chinese people feel financially better off than five 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 purchase everything they can in the world, raises interesting discussion if Yuan had appreciated enough. There is also a trend that more goods are manufactured in vernal WTO members such as Nepal and Vietnam that have price advantage over China. Moreover, in the currency forward market, investors have priced in modes t 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 process that drives RMB exchange rate to an equilibrium level. Recent data also suggests that at current FX level, the rise in trade tautologic 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 Trade 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 estimation still lacks of actual evidence, the scale of growth slowing cumulus in foreign reserve in 2012 is worth attention since it is so large that it is hard to be justified by seasonal adjustment 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 v aluation problem is complex especially given that it is still mostly controlled by government and there are so many dynamic 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 allow a fully conversion Yuan is built on, maybe the real answer can only be found out by then.