×
Home Companies Industry Politics Money Opinion LoungeMultimedia Science Education Sports TechnologyConsumerSpecialsMint on Sunday
×

Why China doesn’t want its currency to appreciate

Why China doesn’t want its currency to appreciate
Comment E-mail Print Share
First Published: Fri, Jul 01 2011. 11 26 PM IST
Updated: Fri, Jul 01 2011. 11 26 PM IST
The Real Exchange Rate and Employment in China, by Ruo Chen and Mai Dao, IMF International Monetary Fund Working Paper http://www.imf.org/external/pubs/ft/wp/2011/wp11148.pdf
The exchange rate of the Chinese currency has long been a bone of contention. Critics say China’s policy of pegging it to the US dollar has led to the yuan being severely undervalued, giving it an unfair advantage in exports. They say the policy is the reason for the country’s huge current account surpluses and, therefore, for global trading imbalances. The Chinese, of course, say it’s all rubbish. But the fact remains that there has been a lot of pressure, particularly from the US, on China to revalue its currency.
Whether China will do so, or not, depends on what it sees as its own interests. In theory, an appreciation of the exchange rate leads to exports becoming more costly, thus losing competitiveness in the short-term. This could lead to loss of jobs and output in the export sector. On the other hand, the appreciation of the currency will mean lower import prices, so sectors that rely on imports into the domestic economy would gain. The question is: What has China’s experience with currency appreciation been really like? What has been the impact on employment? Has only the tradable sector been affected? The authors attempt to answer these questions by examining the impact of exchange rate fluctuations in China on sectoral and regional employment between 1980 and 2008.
Their conclusions are surprising. They find that not only do fluctuations in the exchange rate lead to sizable changes in employment in the tradable sectors of the economy, but they affect the non-tradable sectors as well. A 10% real appreciation of the currency lowers employment growth by 0.4-1.4 percentage points across sectors, except for agriculture. Now, we know why the Chinese are so wary of allowing their currency to appreciate. Why is employment in China’s domestic sector affected by the exchange rate? The authors say the main reason is the linkages that even the domestic sector has with the export sector. For instance, a large share of output from sectors such as transportation, business services, and retail/wholesale trade is used as intermediate input in manufacturing industries, which produce for export. In fact, the percentage of gross output from the banking, transport, wholesale/retail trade and utility sectors used in tradables on average ranges from 30-70%. In other words, the linkages between the tradable and the other sectors are very high in China. The authors say “thus, if a real appreciation leads to a contraction in tradable sectors, the ensuing negative effect on demand for intermediate input can lead to a decrease in employment in non-tradable sectors as well.” Not surprisingly, this effect is larger in those regions of the country that are more open to foreign trade. In short, there are good reasons for the Chinese to be very cautious about allowing their currency to appreciate. But the aim of policy should not be to continue with the status quo, but to take actions to mitigate the pains of the adjustments. Towards that end, the authors recommend, “a real appreciation should, therefore, be accompanied by other macroeconomic policy measures to support domestic demand and structural reforms to enhance the productivity of non-manufacturing sectors of the economy in order to decouple those sectors from demand swings in exports”.
Graphic by Jayachandran/Mint
Comment E-mail Print Share
First Published: Fri, Jul 01 2011. 11 26 PM IST