China's importance for the world economy has increased appreciably in recent years. Rapid economic expansion has boosted China's share of world trade, and the Chinese trade surplus has also grown at a brisk pace. As a result, China has been under pressure to allow its currency to appreciate. In July 2005 China did revalue the renminbi's external value by about 2%. Since then the renminbi has been strengthening against the US dollar, albeit very slowly. However, the dollar depreciation has weakened the renminbi eg vis-à-vis the euro. Inflation in China has also been very low so that the real effective exchange rate has been relatively stable for almost ten years now. It should be noted, however, that even though a number of trading partners have called for revaluation of the Chinese currency in order to reduce the trade surplus, very little research has been done on the impact of the exchange rate on Chinese exports and imports.
This highlights the significance of the recent study by Alicia García-Herrero and Tuuli Koivu (Can the Chinese trade surplus be reduced through exchange rate policy?, BOFIT DP 7/2007), which analyses the implications of the exchange rate for Chinese foreign trade. The study looks at how the real effective exchange rate affects Chinese exports and imports. In order to identify the effects of the real trade-weighted exchange rate, the equations used control for the effects of other factors on exports and imports. These factors include China's industrial output growth, developments in world trade, China's tax incentives for exports and duties on imports, and the volume of foreign companies' investment in China. The study finds that China's exports and imports are highly sensitive to changes in the exchange rate. As expected, renminbi appreciation reduces China's exports. The net effects on the trade surplus are however constrained by the fact that imports to China also decrease with exchange rate appreciation. This is assumed to be related to China's strong position in the international production chains. Many companies import components into China from other countries, and the finished and semi-finished products assembled from these components are then exported abroad. When the price competitiveness of these final goods weakens because of currency appreciation, imports of components to China also decline.
In order to clarify this link, García-Herrero and Koivu also estimated export and import equations separately for China's main trading partners. On the imports side, there is considerable cross-country variation in the results. When China's currency strengthens, imports decrease from those Asian countries that export mainly parts and components to China for further processing. By contrast, imports eg from Germany are to a greater extent targeted at the Chinese domestic market and tend to increase in response to appreciation of the renminbi. The response is similar for other euro area countries. US and Japanese exports to China, by contrast, are mainly components and machinery for the processing sector and other high technology products for which China has no substitutive production. These exports to China are not highly sensitive to exchange rate movements.
The results suggest that the net effects of exchange rate changes on trade flows appear to be smaller for China than for most other countries. This is largely explained by China's position in the international production chains. In order for exchange rate movements to have rapid and important effects on China's external balance, the renminbi would have to undergo a major revaluation. |