On 11 August 2015, the People Bank of China
weakened the yuan by almost 2 percent. The central bank’s move pushed the yuan´s
“daily fix” to 6.2298 against the dollar, and that move was its biggest one-day
change since China had loosened (somewhat) its dollar peg in June 2010.
Financial market observers immediately jumped to two ´conclusions´:
·
While
China´s central bank paid lip service to a more flexible exchange rate regime,
it really signaled panic about China´s slowing growth;
·
The
devaluation wasn´t a one-time shot but the likely entry to a prolonged period
of engineering the yuan down to increase external competitiveness.
Consequently, all China-sensitive asset prices
– such as oil, copper, shares of luxury brands and cars and emerging-market
currencies – dived below their already depressed levels upon the devaluation
news.
I will make the point that the market reaction
and commentary is myopic: Even if the devaluation signals concerns about current
growth, correcting the yuan´s accumulated overvaluation will be good for
China´s growth, emerging countries´ growth as well as commodity and luxury
exports.
Table 1: Yuan BIS
Effective Exchange Rate, 01/2010 – 06/2015
2010 = 100
Some may still doubt that the yuan is
overvalued. The evidence points to the contrary, though. According to the broad
measure of BIS effective (trade weighted) exchange rate, the yuan has
appreciated by some 30% over the past five years (Table 1). According to the
Barclays behavioural equilibrium exchange rate model, the yuan remains the
second-most overvalued currency in the world, by more than 20%[1].
The dollar’s recent ascent has pulled the yuan away from other currencies,
leaving it increasingly overvalued, as the yen has stayed on a soft peg to the
dollar. And even the Peterson Institute, traditionally the US Treasury´s
ventriloquist to accuse China of unfair exchange-rate protection, has recently
calmed down by gauging China´s so-called fundamental equilibrium exchange rate
as ´correctly´ valued[2],
at round 6 yuan per dollar. A further indication of yuan overvaluation is that
the market and Chinese corporates had been expecting a yuan depreciation going
forward: Onshore FX deposits surged in 2014, largely due to corporates holding
more of their export proceeds in foreign currencies. Outflows recorded under
the currency-and-deposits component of the balance of payments had also picked
up, and forwards had been pricing in sizeable depreciation of the yuan versus
the dollar.
Applying Dani Rodrik´s (2010) estimates[3]
that a 10% nominal effective appreciation of the yuan would bring down China´s
annual per capita growth by 0.86%, the 30% appreciation accumulated over the
past five years may have chipped away some, 2.5% from China´s growth rate. This
reduction in China’s growth has translated into a drop of GDP growth in poor
countries (based on our former growth sensitivity estimates of 0.34 per cent)[4]
by one percentage point of annual per capita income growth. The growth link
between China and the emerging markets was even higher, with one percentage
point of growth translating into 0.66% growth. These macroeconomic mechanics of
growth can constitute a certain degree of growth optimism for China, the
emerging countries, commodity prices, and world trade if China´s two percent
devaluation in August is followed upon by the People´s Bank of China.
[1] Solomon Teague (2015), http://www.euromoney.com/Article/3427487/Rising-dollar-makes-renminbi-second-most-overvalued-currency.html, February.
[2] William R. Cline (2014), Estimates of Fundamental Equilibrium Exchange
Rates, November 2014,
Policy Brief PB 14-25, November.
[3] Dani Rodrik (2010), ‘Making Room
for China in the World Economy’, American Economic Review, Papers and
Proceedings. Available at: http://pubs.aeaweb.org/doi/pdfplus/10.1257/ aer.100.2.89
doi:
10.1111/j.1467-9701.2011.01408.x
