The Chinese Exchange Rate

The Issue

China announced several changes to its foreign exchange regime on July 21, 2005, including abandoning the renminbi-dollar peg and pegging to a basket of currencies instead. Despite the policy change, China's currency strengthened very little for two years after reforms were announced and the current account surplus soared to an astonishing 11 percent in 2007. From November 2007 through the end of 2008, however, the pace of appreciation increased substantially. Reinforcing this appreciation were two steps the government took through mid-2008: reducing value-added tax (VAT) rebate rates for a large number of export products and imposing restrictions on the export processing regime. Some of this appreciation is also attributable to the dollar's appreciation against other currencies resulting from the global economic turmoil and the "flight to safety" of investors seeking dollar-denominated securities, with the renminbi "riding the dollar up" during this period.

Despite the more rapid pace of currency appreciation in 2008, PIIE Senior Fellows Morris Goldstein and Nicholas R. Lardy conclude that the renminbi is still undervalued on a real trade-weighted (effective) basis and that a further appreciation—say, on the order of 15 to 25 percent—would be desirable. However, the Chinese authorities—assuming that they don't allow the sizable real appreciation of the renminbi in 2008 to be undone—are not as far "behind the curve" as they were in October 2007 and should continue their currency reforms even in the face of a global economic slowdown. Like most of the rest of the world struggling with the global financial crisis and economic slowdown, economic growth in China has slowed markedly—from 14 percent (at an annual rate) in the second quarter of 2007 to only 6.1 percent in the first quarter of 2009 before recovering to 7.9 percent in the quarter ending in June. China faces a considerably less buoyant outlook for external demand than before the crisis, as seen in the sharp decline in China's exports beginning in November 2008. To mitigate the effects of slowing external demand and promote exports, the authorities have since July 2008 backtracked and raised VAT rebates paid to producers of exported goods.

If China allows little currency appreciation over the coming quarters, continues raising VAT rebates, and global growth converges back toward long-term potential, China's current account surplus would risk expanding once again, perhaps at the rapid pace observed in 2005–07. China's external imbalance is much bigger than it was five or six years ago: Its current account surplus in 2008 was $426 billion compared with $68.7 billion in 2004. China's foreign exchange reserves have also skyrocketed, reaching $2.1 trillion at the end of June 2009.

Essential Reading from the Institute

Testimony: Correcting the Chinese Exchange Rate: An Action Plan
by C. Fred Bergsten, Peterson Institute for International Economics
Testimony before the Committee on Ways and Means, US House of Representatives
March 24, 2010

Testimony: China's Exchange Rate Policy and Trade Imbalances
by Nicholas R. Lardy, Peterson Institute for International Economics
Testimony before the Hearing of the Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Economic Policy
April 22, 2010

Book: Future of China's Exchange Rate Policy, The
Policy Analyses in International Economics No. 87
by Morris Goldstein and Nicholas R. Lardy
July 2009

Book: Debating China's Exchange Rate Policy
edited by Morris Goldstein and Nicholas R. Lardy
April 2008

Book: China's Rise: Challenges and Opportunities (hardcover)
by C. Fred Bergsten , Charles Freeman , Nicholas R. Lardy and Derek J. Mitchell
September 2008

Peterson Perspective: Is China's Economy Overheating? [pdf]
by Nicholas R. Lardy, Peterson Institute for International Economics
Nicholas R. Lardy says China is concerned but is not "slamming on the brakes" or showing any signs of planning increases in interest rates or the value of its currency.
February 26, 2010

Testimony: China's Lending Activities and the US Debt
by Simon Johnson, Peterson Institute for International Economics
Testimony submitted to the US-China Economic and Security Review Commission hearing on US Debt to China: Implications and Repercussions, Panel I: China's Lending Activities and the US Debt
February 25, 2010

Peterson Perspective: China vs. the Rest of the World? [pdf]
by Arvind Subramanian, Peterson Institute for International Economics
Arvind Subramanian argues that exporting countries in Asia, Africa, and Latin America have more reason than the United States to oppose China’s artificially undervalued currency.
February 4, 2010

Peterson Perspective: FEERs Update: China's Persistently Undervalued Currency [pdf]
by John Williamson, Peterson Institute for International Economics
In the light of PIIE's latest update of estimates of fundamental equilibrium exchange rates (FEERs), John Williamson discusses China's currency practices, its undervalued renminbi, and the impact on US-China trade.
January 29, 2010

Peterson Perspective: A Growing US-China Rift [pdf]
by Nicholas R. Lardy, Peterson Institute for International Economics
Nicholas R. Lardy says relations with China are deteriorating over climate change, Iran, and the possible return of global current account imbalances.
January 6, 2010

Speech: Is China a Currency “Manipulator”? [pdf]
by Morris Goldstein, Peterson Institute for International Economics
Transcript from Peterson Perspectives: Interviews on Current Issues
January 28, 2009

Op-ed: China's Currency Needs to Rise Further
by Morris Goldstein, Peterson Institute for International Economics
and Nicholas R. Lardy, Peterson Institute for International Economics
Op-ed in the Financial Times
July 22, 2008

Testimony: The Dollar and the Renminbi
by C. Fred Bergsten, Peterson Institute for International Economics
Statement before the Hearing on US Economic Relations with China: Strategies and Options on Exchange Rates and Market Access, Subcommittee on Security and International Trade and Finance, Committee on Banking, Housing and Urban Affairs, United States Senate
May 23, 2007

Policy Brief 07-4: Global Imbalances: Time for Action [pdf]
March 2007

Working Paper 07-5: A (Lack of) Progress Report on China's Exchange Rate Policies [pdf]
by Morris Goldstein, Peterson Institute for International Economics
June 2007

Op-ed: Is China Having It Both Ways?
by Arvind Subramanian, Peterson Institute for International Economics
Post on the Wall Street Journal's Real Time Economics
March 25, 2009

Op-ed: The Yen Beckons China’s Dollars
by C. Fred Bergsten, Peterson Institute for International Economics
Op-ed in the Financial Times
March 12, 2007

Article: Clash of the Titans
by C. Fred Bergsten, Peterson Institute for International Economics
Article in Newsweek, International Edition
April 24, 2006

Policy Brief 06-6: China: Toward a Consumption-Driven Growth Path [pdf]
by Nicholas R. Lardy, Peterson Institute for International Economics
October 2006

Policy Brief 05-1: A Currency Basket for East Asia, Not Just China [pdf]
by John Williamson, Peterson Institute for International Economics
August 2005