>Yuan Revaluation: Not Necessarily Bad for China

It’s diffi cult, these days, arguing that the yuan is not
undervalued. The widely publicized large current account
surpluses and bulging foreign exchange reserves in China
suggest otherwise and continue to provide fodder to
critics of Beijing’s exchange rate policy. While today’s
revaluation of the yuan was inevitable, given the necessity
to rebalance the global economy, the change in Beijing’s
currency policy need not be detrimental to China.

Why Rebalancing Growth is Important
In fact, a revaluation of the yuan could get China to a more
sustainable growth model faster. While China’s rise to
export prominence was made possible by relatively cheap
labour, the latter won’t last forever, given the rising domestic
wages and the ascent of other low-cost centres (such as
Bangladesh and Vietnam). Note also that consumers are
still a small part of the economy relative to traditional
powerhouses like the US, Japan and Germany (Chart 1).
Strengthening its economic base by stimulating domestic
consumption further, while not relying too much on exports,
is a plus for sustainability of growth. An appreciation of the
yuan goes in that direction, with resources being shifted
from exporters to consumers who will be benefiting from
lower import prices and more choice.

Implications for Trade
The potential harm to exporters, wouldn’t be as dramatic
as feared. Any appreciation of the yuan will result in a
less-than-proportionate increase in the dollar price of
a Chinese product in the US. That’s because only the
domestic component of the product will be impacted
(e.g. the value-added by the producer, refl ecting factors of
production in China). The foreign component of the price,
namely the input prices (such as imports from suppliers),
and US costs (like shipping, retailing, and advertising) will
be unaffected. Of course, that’s assuming that supplier
countries like Japan and other Asian nations do not let
their currencies appreciate as steeply as the yuan against
the US$, a reasonable assumption given policies during
the last yuan revaluation.

Numerous studies1 have noted that the domestic content
of Chinese exports is between 35-55%. Even assuming
the upper-bound of that range, a yuan revaluation of
similar magnitude to the one seen from July 2005 to
July 2008 (i.e. 17% appreciation) would, at worst, raise
the price of imports from China by 9%, not signifi cant
enough to cripple China’s overall exports, especially
considering that any appreciation will be spread out over
several years.

That might explain why China coped well the last time
the yuan was revalued. Trade remained relatively healthy
during the 2005-2008 unpegged period, with exports to
Asia nearly doubling and sales to North America soaring
70%, while exports to other regions were even more
impressive, helped by the yuan’s competitiveness (Chart
2). If history is any guide, a small appreciation is unlikely
to have major detrimental impacts on China’s export
market share.

To read the full report: YUAN REVALUATION