Who Will Gain from a Renminbi Revaluation?

Source: VoxEU

Who Will Gain from a Renminbi Revaluation?A gradual renminbi (RMB) revaluation will help China and a few other countries that compete with China. It will also make China’s growth more balanced and resilient, which is in the general interest.

However, unless RMB revaluation is accompanied by an acceleration in China’s domestic demand, most countries will see little benefit and some countries will lose as their import prices rise and their current account deficits with China widen, at least over the next year or two.¹ Ironically, the United States, which has been leading the charge on RMB appreciation, would likely be among the losers. Certainly, a very large one-off revaluation that disrupts China’s growth hurts everyone.

Renminbi Undervaluation and China’s Growth

Various studies have suggested that the RMB is undervalued, with recent estimates ranging from 15-50 percent (see for example Evenett 2010). China’s very large interventions in support of its currency (its reserves have increased by 40 percent to $2.6 trillion since the crisis began two years ago) lend credence to the view that its exchange rate is undervalued.

Many economists (for example, Corden 2009, McKinnon 2010, Mundell 2010, and ourselves) believe that any RMB undervaluation estimate should be taken with a grain of salt, since it requires many assumptions and China’s current account surplus cannot be explained primarily by an undervalued renminbi. Instead, factors such as the household savings rate, fiscal balance, and tax and other incentives offered to investors and exporters play a more important role.

Recognizing that an RMB revaluation increases the purchasing power of its consumers and is in China’s own interest, Beijing’s leaders have allowed the renminbi to gradually appreciate, amounting to 20 percent against the dollar between July 2005 and July 2008. While the policy was suspended when the global economic crisis began, it resumed in June 2010; the currency has appreciated by about 2.2 percent vis-à-vis the dollar since then.

China’s pre-crisis revaluation—combined with its massive demand stimulus—has served both the country and the world well so far. China’s domestic demand has increased by 41 percent since 2006-2007, and its current account surplus has declined by 5 percent of its GDP. China has contributed about 30 percent (in Purchasing Power Parity terms) of global growth over 2000-2008. Indeed, global financial markets have become as sensitive to developments in the Chinese economy as they are to those in the U.S. economy.

But RMB revaluation will not work for either China or its trading partners if it disrupts China’s highly export-dependent economy and undermines the confidence of investors in its continued growth. According to the IMF, net exports and fixed investment linked to the tradable sector accounted for more than 60 percent of China’s GDP growth from 2001-2008, compared to 35 percent in the rest of Asia and 16 percent in the G-7 economies.

Who Gains?

Evaluating the effects of RMB revaluation is not straightforward. RMB revaluation causes a loss to consumers outside China since they will confront higher prices of goods imported from China. These losses have to be offset against those of producers who will gain competitiveness. Moreover, China’s trading partners are more likely to gain from RMB revaluation if it comes with measures that accelerate China’s domestic demand relative to its GDP. Indeed, without those measures, the effect of RMB revaluation on China’s current account surplus is likely to be marginal or even to widen it.

RMB revaluation will have differentiated impacts on China’s three broad classes of trading partners: low-income commodity exporters, middle-income manufacturing exporters, and high-income manufacturing exporters.

The effects of RMB revaluation on high-income countries will be mixed and will depend on their bilateral trade position with China.

Low-income commodity exporters benefit from China’s continued expansion, as China has attracted an increasing share of their exports—about 7.2 percent in 2009, up from 1.3 percent a decade before. Furthermore, China has become an important source for them of cheap consumer goods as well as machinery, accounting for about 17 percent of their total machinery and transport equipment imports.

In the very long run, a revaluation of the RMB could help commodity-exporters to diversify into basic manufacturers. However, over the next few years, RMB revaluation is unlikely to affect these countries’ exports significantly because the prices of their commodity exports are determined in global markets (and denominated in dollars). However, the dollar prices of China’s exports to those countries are likely to rise, reflecting small profit margins in those sectors and the fact that China, as the biggest exporter of those goods, is the price-setter.

As a result, countries that have largest trade deficits with China, such as Ghana, for example, will be more likely to lose because of the deterioration in their terms of trade (a measure of the difference between the growth of export and import prices). Thus, the commodity exporters are likely to have a much greater interest in China’s continued growth than in RMB appreciation. According to an OECD study, a 1 percent slowdown in China’s growth rates will result in a reduction of around 0.3 percent in growth of low-income economies.

Middle-income manufacturing exporters which show a bilateral trade surplus with China and which compete directly with China in manufacturing exports, such as South Korea and Malaysia, are likely to gain the most from RMB revaluation. Like China, some 45-50 percent of the exports of these manufacturing exporters is accounted for by machinery and transport equipment.

A University of Oxford study shows that China’s average export prices (unit values) have placed substantial downward pressure on those of middle-income countries, but not on those of low-income countries. These middle-income countries are also those that are most likely to see long-term benefit from RMB revaluation, because their export volumes (as well as prices) will expand as they become more price competitive with China in third markets.

Middle-income manufacturing exporters are likely to gain the most from RMB revaluation.

However, middle-income manufacturing exporters have also been relying increasingly on imports sourced in China—nearly 12 percent of their imports in 2009 came from China— and will see their import prices rise with RMB revaluation. Thus, countries such as Vietnam and Hungary, which import much more from China than they export, may be net losers of RMB appreciation, especially in the short term. Measures that accompany RMB revaluation and ensure that demand in China accelerates could offset these effects.

The effects of RMB revaluation on high-income countries will be mixed and will depend on their bilateral trade position with China, which generally reflects smaller deficits as a share of GDP than that of the low- and middle-income countries. The price of their imports from China will rise. However, in countries such as Germany and Japan, this effect will be at least partly offset by their ability to increase prices on their large exports to China. Because the technology-intensive and differentiated nature of their exports makes them less price sensitive, their exporters may choose to leave their RMB prices unchanged and take increased profits. Since they do not, for the most part, compete with China directly, they are unlikely, however, to see large gains in third markets or long-term volume gains from RMB revaluation.
 

The United States and Italy are in a less favorable position because their imports from China are about three to four times larger than their exports to China. As a result, they are likely to be significant net losers from RMB revaluation and see their bilateral trade deficit with China widen unless offset by a substantial acceleration in China’s growth. The rise in the price of their imports from China (consumed widely and disproportionately by low-income households) will outweigh the profit-enhancing effect of the rise in the price of their more sophisticated exports to China.

In both the United States and Italy, the widening of the bilateral trade deficit with China may become permanent because neither import nor export volumes are likely to react enough to offset the large terms of trade deterioration. Other middle-income exporters may, however, take share away from China on U.S. and Italian markets. Intra-firm imports of U.S. multinationals from their affiliates in China—which accounted for nearly 30 percent of U.S. imports from China in 2009 —will probably be hurt except in cases where they have diversified their sourcing to include competing middle-income manufacturer exporters. 

Conclusion

The greatest beneficiary from a gradual RMB revaluation, accompanied by measures to stimulate demand, will be China itself. Its growth is likely to be more balanced and resilient, and that will have a positive spillover on the rest of the world, including by reducing currency and trade tensions.

Some middle-income manufacturing exporters running a trade surplus with China will benefit, too. Other middle-income exporters that import a lot from China could be net losers from the hike in China’s export prices in the short term, but gain as their export volumes expand at China’s expense.

Low-income commodity exporters will generally be net losers from RMB revaluation alone and will only benefit if China’s growth accelerates because of accompanying measures taken by the Chinese authorities.

Countries such as Italy and the United States—whose initial trade deficits with China are large—will very likely lose.

Some high-income countries, such as Germany and Japan, which have an initial small trade deficit with China, may lose or gain a little from RMB revaluation alone. However, countries such as Italy and the United States—whose initial trade deficits with China are large and whose exports are not competitive with China’s—will very likely lose, and their lower-income consumers will suffer most as the price of Chinese goods rises.

This conclusion does not imply a judgment that a large bilateral trade deficit in Italy and the United States with China is good or bad. It only implies that RMB revaluation is not the way to fix the deficit problem. Instead, increasing national savings rates in Italy and the United States, and increasing consumption in China would be more effective.

Given China’s high dependence on price-sensitive exports, a large one-time RMB revaluation may carry unacceptable risks to its growth and stability. In the event of a sharp slowdown in China, those countries that are likely to lose from RMB revaluation anyway, starting with the United States, could suffer a proverbial double whammy.

Uri Dadush is the director of Carnegie’s International Economics Program. Shimelse Ali is an economist in Carnegie’s International Economics Program. This article was originally published in the International Economic Bulletin.

^{1. In the economic literature, the initial (one to two year) widening of the trade surplus in the event of a revaluation is known as the J-curve effect, and reflects the fact that export and import prices react much faster than volumes.}