Yuan Revaluation: Not Necessarily Bad for China

It’s diffi cult, these days, arguing that the yuan is notundervalued. The widely publicized large current accountsurpluses and bulging foreign exchange reserves in Chinasuggest otherwise and continue to provide fodder tocritics of Beijing’s exchange rate policy. While today’srevaluation of the yuan was inevitable, given the necessityto rebalance the global economy, the change in Beijing’scurrency policy need not be detrimental to China.Why Rebalancing Growth is ImportantIn fact, a revaluation of the yuan could get China to a moresustainable growth model faster. While China’s rise toexport prominence was made possible by relatively cheaplabour, the latter won’t last forever, given the rising domesticwages and the ascent of other low-cost centres (such asBangladesh and Vietnam). Note also that consumers arestill a small part of the economy relative to traditionalpowerhouses like the US, Japan and Germany (Chart 1).Strengthening its economic base by stimulating domesticconsumption further, while not relying too much on exports,is a plus for sustainability of growth. An appreciation of theyuan goes in that direction, with resources being shiftedfrom exporters to consumers who will be benefiting fromlower import prices and more choice.Implications for TradeThe potential harm to exporters, wouldn’t be as dramaticas feared. Any appreciation of the yuan will result in aless-than-proportionate increase in the dollar price ofa Chinese product in the US. That’s because only thedomestic component of the product will be impacted(e.g. the value-added by the producer, refl ecting factors ofproduction 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) willbe unaffected. Of course, that’s assuming that suppliercountries like Japan and other Asian nations do not lettheir currencies appreciate as steeply as the yuan againstthe US$, a reasonable assumption given policies duringthe last yuan revaluation.Numerous studies1 have noted that the domestic contentof Chinese exports is between 35-55%. Even assumingthe upper-bound of that range, a yuan revaluation ofsimilar magnitude to the one seen from July 2005 toJuly 2008 (i.e. 17% appreciation) would, at worst, raisethe price of imports from China by 9%, not signifi cantenough to cripple China’s overall exports, especiallyconsidering that any appreciation will be spread out overseveral years.That might explain why China coped well the last timethe yuan was revalued. Trade remained relatively healthyduring the 2005-2008 unpegged period, with exports toAsia nearly doubling and sales to North America soaring70%, while exports to other regions were even moreimpressive, helped by the yuan’s competitiveness (Chart2). If history is any guide, a small appreciation is unlikelyto have major detrimental impacts on China’s exportmarket share.

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