Wednesday, 14 May 2014

On the Renminbi, May 2014

Something astonishing has happened: Arvind Subramanian now thinks that the RMB is no longer undervalued although he is part of the Peterson Institute for International Economics, ahem,   “perhaps the world’s top econ think tank”. He and his coauthor Martin Kessler used the preliminary results of the 2011 International Comparison Program that were released by the World Bank on 30th April. One aspect of the ICP 2011 results is that we now can update the Balassa-Samuelson (or Penn) effect: the national price levels that are closely correlated with relative per capita income as services and other nontradables are cheaper in poorer countries. Chris Garroway (UNCTAD) has produced the graph below. The red dot indicates China; take a linear OLS and conclude that by 2011 China was still slightly undervalued (by ca 8%); or take a better fit, a nonlinear function, and the RMB was already correctly valued by 2011.

 Since mid-2011, almost three years have passed. Messrs. Kessler and Subramanian use the new PPP calculations to estimate that between 2011 and March 2014 China’s per-capita GDP grew about 13 percentage points faster than the U.S., which they say should translate into a currency appreciation of around 3.2%. Since the actual appreciation was 7%, they conclude “The renminbi in 2014 is thus fairly valued”. Kudos to the authors since this is an honest assessment for people earning their dollars in an opaquely financed[1] and US-Treasury led think tank.

In fact, since mid-2011 until March 2014 (for which the latest BIS data for real effective exchange rates are available), the renminbi has appreciated by 15% (not 7%); in January this year, the accumulated appreciation had even be 18% before the renminbi started to drop. Take the growth differential to the US and allow 3.2% ´warranted´ appreciation, we can conclude that the renminbi end March was overvalued by 7% early 2014: the slight undervaluation of 8% in 2011 plus the ´warranted´ appreciation of 3% were overcompensated by an 18% real trade-weighted appreciation as measured by the BIS.


RMB Appreciation since ICP 2011 Cutoff



China´s authorities are thus unlikely to tolerate any further real appreciation of the renminbi. Yes, the real exchange rate is an endogenous variable but already Chicago´s Arnold Harberger showed  that it can be influenced. The most likely way forward to dampen the RMB is liberalization of capital outflows.  Chinese regulators recently announced a “mutual stock access” plan, under which investors in Shanghai and Hong Kong will be permitted to buy foreign stocks in both directions across the border.

The end of RMB appreciation and thus is good news for poor countries as they would benefit (again) disproportionately from China. Rodrik (2008)[2] had presented evidence that growth in large ‚dual‛ economies such as China and India is supported by a competitive exchange rate. And Rodrik (2010)[3] had produced panel regressions which suggest that a 10% nominal effective appreciation of the Renminbi would reduce China’s annual per capita growth by 0.86 percentage points. In the absence of perfect financial markets, a competitive exchange rate is a powerful policy instrument to incentivize resources (including subsistence labour) to move from low- to high-productivity sectors. High-productivity activities are concentrated in otherwise inefficiently small export industries, which hold the learning capacity through gradual technological and skill upgrading of productive activities that allow increasing sophistication and value-added in domestic production.


[2] RODRIK, D. (2008), ‚The Real Exchange Rate and Economic Growth‛, Brookings Papers on Economic Activity, Vol. 2.
[3] RODRIK, D. (2010), ‚Making Room for China in the World Economy‛, American Economic Review, Papers and

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