PRC Revaluation Won't Solve Global Imbalances

MANILA, PHILIPPINES (2 June 2005) - Contrary to popular belief, a revaluation of the renminbi of the People's Republic of China (PRC) would have little impact on global imbalances and the US trade deficit, but it may contribute to a soft landing in the PRC economy.

This is according to ADB Economist Cyn-Young Park in her paper on "Coping with Global Imbalances and Asian Currencies." The paper is part of the Policy Brief Series produced by ADB's Economics and Research Department, designed to provide concise non-technical accounts of major policy issues.

Macroeconomic simulations conducted by Ms. Park show that a projected 10% revaluation of the renminbi would only improve the US trade balance by $3.6 billion, a mere 0.02% change in the current account as a percent of gross domestic product (GDP). Even with a 20% revaluation, the situation changes little, contributing only to a 0.05% reduction in the current account deficit.

Ms. Park argues that despite the PRC's significant trade surplus with the US, this is the case because imports from the PRC account for a relatively small share of total US imports, and exports to the PRC constitute an even smaller share of total US exports.

Also, for the US trade balance, reduced imports from the PRC would likely be offset by increased imports from other Asian countries. Further, the negative income effect of a revaluation on the PRC economy would curb its import demand, thus making it unlikely that US exports dramatically increase following a renminbi revaluation.

On the other hand, a revaluation may have small but positive impacts on other Asian economies, which would benefit from a shift of trade surpluses and a diversion of capital flows from the PRC. Although a revaluation induces an appreciation of other Asian currencies, this appreciation remains small, as such increasing the relative competitiveness of these countries.

"Normalization of global imbalances requires more fundamental changes in both the US and the global economy," says Ms. Park.

"Whereas the US government should continue to rein in expansionary macroeconomic policies, restrain fiscal spending, and ensure financial prudence in the private sector, the rest of the world needs to make conscious efforts to alleviate external imbalances by encouraging domestic-demand and narrowing the growth gap."

Still, a revaluation has the most significant impact on the PRC economy. The study suggests that a revaluation of 10% could considerably stabilize the PRC's overheating economy by suppressing inflationary pressure, reducing investment, and GDP growth. However, a 20% appreciation or more nearly halves GDP growth, risking a hard landing.

"The choice of appropriate exchange rate policy has to be made in tandem with effective aggregate demand management system," says Ms. Park.

"There are some positive considerations for a revaluation as the study suggested. However, a revaluation may also entail unpredictable risks, such as a hard landing of the PRC economy, unexpected exchange losses of unhedged firms if the revaluation is too big, and more speculative capital inflows if the revaluation is too small. While a revaluation could be an intermediate step towards a more flexible exchange rate, the PRC Government needs to establish more comprehensive strategic plans to phase out a fixed exchange rate in combination with appropriate macroeconomic policies and structural reforms to strengthen its financial sector to sustain long-term high growth."

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