Lovely Professional University School Of Business And Applied Arts Presentation on: POLICY OF DEVALUATION : “A CASE STUDY OF CHINESE ECONOMY” Presented By Sumair Nabi Asma Khanam & Jehangir Ali

World's most populous country with a population of over 1.3 billion.

China is 3rd biggest country in the world in term of area.

The 1st in manpower (in term of population). 2nd economy (in terms of nominal GDP) of the

world after United State of America (USA). More than 700 million of its 1.3 billion people

live in rural area, The 2011 Human Development Report shows

China lies at 101 in a list of 187 countries China's economy during the past 30 years

changed from a centrally planned system to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy.

It refers to decline in value of a currency with respect to other currencies, which is most of the times brought by central bank.

It should not be confused with term depreciation of currency which is a decline in currency value due to market forces without interference of government.

This happens mostly in developing countries which don’t allow currency prices to be determined by market forces.

They want to avoid financial crisis, for which they adopt policies to maintain a stable exchange rate to minimize exchange rate risk and save their gold (foreign currency) reserves. 

The nation will be forced to devalue its currency if its market is too weak to justify the exchange rate. Example a country has depleted foreign reserves and is not credit worthy to borrow from IMF then it has to pay for its imports by devaluation. When currency is overvalued or a country wants to reduce trade deficit then devaluation is used as a policy tool.

Since 2003, devaluing its currency to gain a competitive market in exports.

China purchases billions of US dollars at a time using its currency, thereby flooding the market with yuan, making it cheaper, and the US dollar expensive in international currency markets.

Provides an advantage for China because with a cheaper currency, purchasing Chinese goods is cheaper. This has made Chinese exports soar over the past years and indirectly hurt the exports of other countries

China is running a huge trade surplus. China is slowing the world’s economic recovery with its currency devaluation policy, estimated at 40%.

When the People’s Bank of China-Central Bank Of China buys or sells currency (own or foreign) not only to set that particular desired value of own RBN-Yuan currency, but in order to achieve Additional Objective like running a huge GLOBAL TRADE SURPLUS with rest of the world (exporting more than importing).

China manipulates its currency by setting its value lower than it is worth truly worth.

Value of currency depends on:(i)Relative Economic Growth (positive

relationship)(ii) Relative price level ( negative

relationship)(iii) Relative real interest rates( positive

relationship)

Within the Keynesian framework, currency devaluation boosts economic growth by promoting net exports, aggregate demand, and output through the multiplier effect

On the supply side, devaluation is clearly contractionary. Production suffers because imported inputs get costlier following a real devaluation.

From 1985 to 1993, the Chinese government

devalued the two exchange rates against the dollar several times. These devaluations were not realized

simultaneously most of the time. Often, one of the two rates stayed stable and played the role of a monetary anchor. It contributed thus to slow down inflation, and favoured the real depreciation of exchange rate.

On 1st January 1994, China radically changed its policy. The double exchange rate system was suppressed; the swap rate became the unique official rate for all transactions.

On 21 July 2005, the Chinese authorities decide to revalue the renminbi of 2.1% vis-à-vis the dollar, to switch from the dollar peg to a basket, and to allow the currency to float more freely.

Since this date, the renminbi was progressively revalued against the dollar.

From 2005 to 2009 the renminbi appreciated of 17% in terms of dollars and its real bilateral rate appreciated of 18 %.

Asia: maintain export as element of business model.

Europe: Euro provides opportunity for domestic growth,

uncertain opportunities for exports.

U.S: Slow domestic growth, other than technology

(little domestic opportunities). Looking external for opportunities.

Most important among Asian countries, market of 1.2 billion people have not

been Subject to the currency crisis and is

subjected to pressure. Economic growth - Revised GNP growth for China 7% -GNP Growth for world 2%.

 China is growing in both power and influence. It overtook Japan as the second largest economy.

Growing at a much faster rate than Japan, about 10% annually.

Globally, it has the following impacts... Fastest-growing major overseas market for

the United States. Undervalued yuan helps China’s export sector by making foreign imports more expensive, and Chinese exports cheaper. It encourages outsourcing production and jobs from the United States, contributing to unemployment at home.

Till 1990s .China was successful at maintaining a currency peg against US dollar, using monopoly.

But later China devalued its currency for which it was blamed by various countries for relying on it ( promote exports).

It has the gains in two ways: Its exports become more competitive. It attracts higher foreign investment.

Let us assume 1 USD = Yuan 100.Now if a good costs Yuan 200 in china, a buyer in the US will have to pay USD 2 .Now if China were to devalue its currency to USD 1 = Yuan 200, what would happen??

Now the same product which was costing Yuan 200 in China would Cost the American buyer only USD1 instead of USD 2.

Due to it, Chinese goods have been selling to across the world and countries find it inexpensive to buy from China, getting economies of scale which if may pass to on to its customers ,thereby making their goods more competitive.

Considering the second point, It would need a huge market and low costs of production, like labour and land. So its clear China’s exports surpass its import requirement and hence the trade off is in favour of China..

Another challenge is of rising inflation. As the yuan devalues, the central bank will

have to print more yuan to balance the surge in dollars through increased trade. But as china has abundant land and labour,they are able to off set the inflationary pressures by higher productivity through economies of scale.

Also ,China is not democratic like India hence people’s voice against inflation would be suppressed.

The value of trade between the United States and China is more affected by currency changes than that of the US-Euro area or the Euro area-China.

The 10% depreciation of the US dollar leads to 10%appreciation of Chinese-Yuan.

Euro area trade with China is less impacted by changes in exchange rates.

Note: All figures are in millions of U.S. dollars on a nominal basis, not seasonally adjusted.

Table is taken from U.S Department of commerce: United States Census Bureau

In 2012:-203,121.5 In 2011:-295,422.5 In 2010:-273,063.2 In 2009:-226,877.2 In 2008:-268,039.8 In 2007:-258,506.0 In 2006:-234,101.3 In 2005:-202,278.1 In 2004:-162,254.3

China should take into consideration inclusive growth.

Constant large trade surplus(devaluation) is not a good strategy as due to it economy is

largely effected by global economic changes. There is a desperate need of restructuring the

economy, china must resort to it. China must let the value of it's currency by market

forces to maintain political and economic stability globally.

China should more emphasize on the quality of its products in the global market rather than availability on lesser price.

China should use its trade surplus to increase the standard of living of its rural population rather than buying US securities.