Future of Yuan

8/8/2019 Future of Yuan

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By: Vishwa Rajath (Banking Ist Year)

Ankit Singh (Banking Ist Year)

Ruhi Sood (Banking Ist Year)

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y Renminbi was always officially pegged to the USD,hence mainland China has always had a fixed currencyregime

y RMB/USD declined from 1.5 to 8.62 (lowest) by 1994

y In 2005 the peg was lifted and Renminbi was officiallyallowed to float, although in practice it was a very dirtyfloat

y But when the crisis hit the world economy in 2008 the

peg was unofficially reinstated, until then theappreciation was 21%


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y Until 2008 the rest of the world was hoping thatRenminbi would appreciate towards its real value dueto market forces but since 2008 PBoCs unofficial

pegging of RMB has generated lots of hue and cry from world leaders and central banks

y According to every report/statistics by central banksRMB is at least 25% below what is should be

y

On June 20th

, one day before G20 meet in Toronto,PBoC promised to allow RMB to float more freely,fearing labeling of currency manipulator by Fed Res.


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Since the G20 meet the RMB did appreciate from 6.82 to 6.68 but since twoweeks it has stagnated around 6.76-6.78, making many to believe that PBoChas retreated from its promise


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y Price of Big mac in China = 11 RMB

y Price of Big mac in US = 3.3 $

y Purchasing power parity (PPP)= 3.3/11 = .3y Actual Foreign Exchange Rate (FX): 1/6.76 = .1479

y Big Mac Index: [(PPP-FX)/FX]*100 = -50.7%

y

Value of Big Mac index quoted by The Economist = -48%, according to their 22ndJuly issue


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y World Bank holds ICP a survey to collect the prices &expenditure data for the all the goods & services(including consumer goods & services, government

services & capital goods) that comprise GDP.

y The ICP uses PPPs to do this because PPPs are bothcurrency converters and spatial price deflators. In

other words, they are conversion rates that bothconvert to a common currency and equalize thepurchasing power of different currencies in the processof conversion.


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Real exchange rate = 3.52

( / ) ( / )y

x

PQ x y S x y

P

!

GDP of ChinaGDP by PPP in trillion dollars: $ 9.40Nominal GDP in trillions : $ 4.90

Comparison factor kk = GDP (PPP)

GDPk = $ 9.4$ 4,9

k = 1.92Real Exchange rate

Real exchange rate = Current exchange rate/kReal exchange rate = 6.76

1.92

The same number by IMFs PPP data comes out to be : 3.79


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y While the PPP and Real Exchange Rate calculations are not veryaccurate measurements and take a lot of assumptions, excludeother costs, quality, etc., still Law of One Prices dictates that ifRMB was allowed to freely float its equilibrium rate shouldappreciate to above 4 against USD

y We created our own Index Shef Index (Salt, Haircut, Electricityand Flour), the four major indicators of price levels in China

y The Shef Index predicts that the Yuan is 55% undervalued

y Taking the different predictions of Real Values of Yuan we see

that it is 40-55% undervalued giving us its real value anywherebetween 4-3 against the dollar

y Our estimate is somewhere between these numbers and we saythat Yuan is 50% undervalued, making its real value to be 3.38


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y We can safely assume that RMB is still under fixed currencyregime and that any hopes of its significant appreciation inshort-term are ill-founded

y This is especially so with the crisis continuing in the west

(European Sovereign Debt Crisis, weakness in USA andJapan), China is expected to follow the same line tostrengthen its exports

y From Chinese point of view they are going to care forthemselves first and continue on the path of development

they are following with a devil may care attitudey Beijing consensus is to keep quite, bide their time, ignore

the rest of the world as long as they can


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y People can argue that world economies can ban Chineseimports or go to WTO or impose import on Chinese goods

y Some countries, like India, already do that, some like USAdo it with one or two products (like tyres in USA) or fight along drawn battle inWTO

y None of these strategies have worked or will work in thelong or short term future (current account deficits for bothIndia and USA against China have risen consistently)

y Japan and Germany were bullied by USA in 80s toappreciate their currency, thanks to which Japan lost twodecades of development


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y Chinese scholars know that they will suffer the samefate as Japanese if they allow themselves to bepressurized

y China will be the largest economy in the world before2030, by all means, till then it would be day-dreamingon part of the world economies to expect China to stopmanipulating its currency

y To quote the dean of Fudan University China will go

to war with the rest of the world to protect itsfundamental interests, including Renminbi

y In essence the world can do Nothing


13/15

y People may argue that China can effectively control itsinflation and the minor debt problem, if it lets its currencyfreely float and appreciate as a result

y China has managed its inflation effectively without usingexchange rate and its debt problem is not compounding

y Besides, they love making Made in China goods, ForeignTrade is more than 40% of GDP

y Foreign Trade has consistently beaten their overall growthrate, hence they would not want to threaten their keygrowth rate driver if they are competing with USA for sizeof economy

y China may allow more flexible fx regime as its per capitaincome increases, labor and material costs rise and peoplehave more money and desire to buy foreign goods


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y The Economist Big Mac Index and Opinion Pieces

y Washington Post for current news regarding RMB

y IMF For PPP and other GDP data

y ICP/World Bank for PPP and comparisons of economies

y Time Magazine For diplomatic and political opinions of Yuan Issue

y

OECD for OECDs expectations from Chinay CIAWorld Fact book for CIAs opinion of Chinese Economy

y Xinhua News Agency For Chinese Point of View

y China Global Times

y New York Times

y Economic Times

y Financial Times

y UBSs price and earnings report

y BRIC Report

y Books Imad Moosa International Finance, Samuelson Macroeconomics

y www.xe.com


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Future of Yuan