Impact of china’s exchange rate policy on the world economy

Impact of china’s exchange rate policy on the world economy

Introduction

Over the past few years, Chinas economy has been on an upward trend that it has risen to be the second largest after that of the United States. With the economy’s rapid and steady rise, it has caught the attention of worlds large economies and economic analysts. Chinese corporations and enterprises have in that regard increase their competitiveness all around the globe, which attributes to the ever-increasing foreign investments, low currency value, and cheap labour force. Chinese economic rise is mainly due to an increase in their export. The Chinese government have also reduced the valuation of the country’s currency Yuan/Renminbi (RMB) exchange rate about its equilibrium, contributing to even more upswing in the economy. By making their currency value lower, they thus affect the number of exports by making them cheaper than those from competing economies than it would have the exchange rate left flexible and allow for the appreciation of the currency.

This undervaluation of the Yuan has resulted in the distortion of the world’s economic fundamentals, bringing about unfavourable effects on the macroeconomic performance and the economic structure of the world’s economy. This move has resulted in numerous controversies across several countries. For example, technological exports from China compete directly with those from the European union having a comparative advantage. Many governments are thus in agreement for cooperation with China to bring about a better balance in the functioning of the international monetary system.

Chinese exchange policy has undergone various changes in recent years. The nominal exchange rate of RMB to USD has undergone significant evolution from the period between 1980 to date with a reversal onwards of 1994. RMB appreciation wasn’t pronounced as depreciation observed during the initial periods of Chinese economy reforms implementation.

In the periods leading to the late 1970s, a centralised system of exchange rate control prevailed. However, while the economy progressed through the reforms process, so did the exchange rate regime changed to become a dual system. This system would later be unified in the year 1985. The Asian crisis outbreak of 1997 forced the Chinese monetary authorities to fix the rate of exchange against the US dollar a move that remained in effect until July 2005.

Succumbing to pressure the People’s Bank of China (PBoC) allowed for a 2% appreciation of the Renminbi against the US dollar and announced the adoption of currency float management system based on a pool of currencies. This decision introduced greater flexibility in the relationship between the world currencies and the Chinese currency Yuan/Renminbi. This move resulted from external from the United States and the European Union, who argued that maintaining a fixed and artificially low valued exchange rate hurt the export competitiveness of North American and European products. In these conditions from 2005-2008, the Chinese currency appreciated by 18.6% in the actual practical terms and about 16% in nominal terms against the United States dollar. However, as the financial crisis intensified in the US once again, the Chinese government froze the value of their currency against the dollar in July of 2008.

The Chinese exchange rate policy has had the primary goal of increasing the capacity of the country’s export by practising strict control over the exchange rate. Other factors that prompted Chinese lawmakers to take even greater control of the exchange rate are the desire to maintain internal and external macroeconomic stability and avoid pressures from inflation and the need to promote an industrial structure gradual adjustment. This development technique relying on the export sector was created with detailed and careful analysis of the way other industrialised countries, i.e. Japan. Taiwan and South Korea have become wealthy.

However, the exchange rate stiffness witnessed for several years in China is attributed as one of the main factors for the continuous worsening of various economic and financial fluctuations in the world. In the context of proceeding evolution and strict control of the currency value, the reflection in prices of exports as the measure of regional trade and capital flows is tiny. Hence, the United States and the European Union constant call for a flexible system of exchange in china, an immediate consequence which would be in the appreciation of the value of the RMB. Averagely the Chinese currency is undervalued by about 20% and 27% of the dollar and when compared against the real effective exchange rate respectively.

The integration of China into the World trade

China’s economy has continuously stabilised and assumed a strong position in international business with more pronunciation during recent years. When compared to other developing and emerging nations, China stands out due to the high growth rates observed in periods after reforms and about the fast integration into international trade. They would later adopt a process of socio-economic changes that involved the diversification of property forms and promoted a more decentralised and market-driven economy. These reforms contributed to China’s integration to the World Trade Organization (WTO) in December 2001. The addition of China to the World Trade Organization allowed for a structural shift in their economy bring it the opportunity to become modernised technologically. Another advantage that China gain was its freedom to participate in the implementation of World Trade Organization rules freely. This accession to WTO has reflected in high growth rates of real gross domestic product.

China allowed outside companies to operate in its territory and utilise its market, the country established requirements as joint ventures and realisation of local research and development institution. With relations to exports, this also showed exponential growth. When we observe export share of China’s GDP, we realise that in the early 1980s it reflected at 8%, but in the middle of 2006, it had peaked at almost 40%. Between 1992 and 2005 the exports from china grew annually by a rate of about 18%, which was more than double the rate the world exports grew. These strong export performances were the attributing factors in implementing trade policies and the exchange rates, of Foreign Direct Investment (FDI), of import increase in capital goods and greater efficiency in their manufacturing industries.

A point to note is that most of the Chinese export growth attributed to foreign companies who have outsourced their production in China and Chinese companies which have received investments from external sources. This growth is due to the readily available cheap and low skilled labour force.

To conclude due to the strong position that the Chinese economy is at, it has had the power to influence world market due to its large export market share by undervaluing its currency resulting in favourable conditions for foreign investors. When pit along with site competitors, given it the sheer number of labour, the Chinese economy has world domination, and that makes it the fastest growing economy in the world.