Financial Daily from THE HINDU group of publications
Sunday, Jul 31, 2005
Financial Daily from THE HINDU group of publications Sunday, Jul 31, 2005 |
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Investment World
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Economy Money & Banking - Forex Columns - Simple Economics Effects of the yuan revaluation B. Venkatesh
China revalued the yuan last week. What are the implications of this move? China currently exports more goods to the US than it imports from it. So, it holds piles of US dollars, which its exporters have earned. After revaluation, the Chinese need only 8.11 yuan to buy one US dollar; they needed 8.28 yuan earlier. So, those holding US dollars will now receive lesser yuan for every dollar. This also means that the dollar reserves that China holds will decline in value. Next, consider the dollar inflows into China. If exports are higher than imports, US dollars will continue to pour into China. This means the demand for yuan will go up. Why? Chinese exporters will have to convert their US dollar earnings into local currency. The demand for yuan will push up its value against the dollar in the unofficial forex market. To prevent the difference in official and unofficial rates, the Chinese central bank will have to buy dollars. And that means selling yuan and buying dollars. This process will release more yuan in the domestic market. More supply typically leads to lower prices. So, lending rate for yuan will come down. This will fuel credit boom, which the Chinese government does not want. So, revaluing the yuan could help lower the dollar inflows into the country, as it would make imports by the US costlier. Ironically, however, the current revaluation could actually result in more short-term inflows. Why? This move is likely to trigger expectations of several such revaluations and ultimately, perhaps, to a free float of the yuan against the dollar. So, holding yuan instead of dollars makes economic sense. Naturally then, currency traders and Chinese expats may be busy selling US dollars and buying more yuan!
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