The Effect of RMB Exchange Rate Volatility on Import and Export Trade in China

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1 The Effec of RMB Exchange Rae Volailiy on Impor and Expor Trade in China Wanhui Jiang School of Public Adminisraion, Souhwes Jiaoong Universiy P. R. China DOI: /IJARBSS/v4-i1/572 URL: hp://dx.doi.org/ /ijarbss/v4-i1/572 ABSTRACT:The exchange rae volailiy always plays a key role in impor and expor rade. This paper invesigaes he effec of nominal RMB exchange rae volailiy on economic growh in China from 1981 o Through he ADF saionary es, he co-inegraion es, and he associaed economeric model and he empirical analysis, he paper concludes ha in he long run, exchange rae change has a posiive impac on impor and expor rade. Therefore, i is necessary o ake relevan policies and measures o adjus he RMB exchange rae a a reasonable level o avoid he RMB sharp appreciaion in he shor-erm o promoe a raional and efficien developmen for China's foreign rade. KEY WORDS: RMB exchange rae;exchange rae volailiy;expor rade;impor rade 1. Inroducion The issue of he Renminbi revaluaion has always been a focus a home and abroad for many years. Afer many imes reform in he RMB exchange rae, China has sared a managed floaing exchange rae sysem since In he early days, he RMB always in a depreciaed siuaion, bu since 2005 he RMB has been showing an appreciaion rend. Especially afer he oubreak of he global financial crisis in 2008, he RMB has been facing a consanly appreciaion pressure, and his makes an imporan impac on China's rade and economy (Xiaoyan Pai, 2008). According o economic heory, he appreciaion of a counry's currency will be beneficial o i's impor, bu have a bad influence on he expor, which will affec a counry's foreign rade (Yulu Chen, 2008). However, differen counry has differen economic condiions, so he appreciaion of currency may have differen effecs on a counry s impor and expor rade. Since Chinese economic reform and opening up, hrough he changes in China s real economy developmen, he value of RMB has experienced a progress from devaluaion o appreciaion, bu China's foreign rade has always been showing a favorable balance, and in mos cases he surplus coninues o grow. This phenomenon has aroused scholar s widespread aenion a home and abroad. Changjun Yue and Ping Hua (2002), hrough sudying China s annual economic daa for all provinces, concluded ha he RMB appreciaion caused a reducion on expor rade volume, besides ha here is an increasing rend on price elasiciy owards China s expor producs. Xiangqian Lu and Guoqiang Dai (2005) using he year of RMB real exchange rae and China's impor and expor daa, and hrough VAR model and oher empirical 615

2 ess, analyzed he relaionship beween real exchange raes and China s foreign rade. The ess proved ha he RMB real exchange rae flucuaion had a significan influence on China s expor, and Marshall-Lerner condiion was saisfied in China, and exchange rae flucuaions exiss J-curve effec on China s impor and expor rade. Weixian Wei (1997) using coinegraion approach o analyze he year expor rade and real exchange rae dae, concluded ha since1978 here has exised long-run equilibrium and causaion relaions among expors and real exchange rae and long-erm expor growh mainly depended on he rising of exchange rae. Chou (2000) sudied he relaions beween he expor volume of differen rade deparmen and he exchange rae in China and also he relaions beween i s oal expor volume and he exchange rae according o he daa from 1981 o 1996, and indicaed ha here exised a negaive long-run equilibrium relaion beween expors and exchange rae. Marquez and Schindler (2006) sudied relaions beween real exchange rae and foreign rade volume based on he monhly dadas from 1992 o 2004, and esablished he model of he relaionship beween exchange rae and impor and expor. Through analysis of he model, hey found ha he rise in RMB exchange rae would bring differen degree reduce of impors and expors. In addiion, some scholars concluded ha here are no significan relaions beween exchange rae and foreign rade. Rose and Yellen (1989) sudied hiry developing counries daa including China and found ha abou 28 counries does no exis significan relaionship beween real exchange rae and foreign rade hrough empirical research. Cerra and Saxena (2002) using he quarerly daa of China from 1985 o 2001 and hrough empirical sudies, proved ha expors were no sensiive o exchange rae flucuaions, which means here is no significan relaionship beween exchange rae and foreign rade. Obviously, he relaions beween RMB exchange rae and China's foreign rade is complex, and unil oday he scholars a home and abroad haven reached same conclusion on his problem (see Yang Cao and Jianwu Li, 2006; Fuyou Lee and Min Sun, 2013; Caiyun Zhou and Taisong Cao, 2008; Jianguo Xie and Ligao Chen, 2002, ec). On he basis of he relevan researches a home and abroad, his paper analyzes he RMB exchange rae volailiy and China's foreign rade siuaion. Through he heoreical and empirical analysis, his paper invesigaes he effec of nominal RMB exchange rae changes on impor and expor rade in China from 1981 o A he same ime, i combines China's economic developmen saus o discuss he effec of RMB exchange rae change on China's overall economic developmen o pu forward some valuable poliical suggesions, oo. 2. RMB exchange rae change and impor-and-expor rade According o he scholars research a home and abroad, we can conclude ha exchange rae decline will reduce foreign rade volume. A counry's real exchange rae decline may cause currency appreciaion, and relaively speaking he domesic price of produc will increase in he inernaional marke, which will cause a fall demand for domesic producs and damage o he expor rade. A he same ime, he domesic marke price of foreign producs will relaively lower, which may simulae he demand for foreign goods, hen leading o he rise of impors. However, some scholars wih differen opinion believe ha exchange rae decline will have expansionary effec. In addiion, oher scholars sugges ha he exchange rae decline will have 616

3 differen economic effecs for he developed and he developing counries. In shor, differen counries have differen economic environmen and rade siuaion, and exchange rae flucuaion may cause differen impacs on real economy. Therefore, i is necessary o analyze he siuaion on he basis of realiy. The volailiy of exchange raes may influence a counry's rade balance. According o he Marshall-Lerner condiion, when he elasiciy of a counry's impor and expor goods mees he condiion, a counry's currency devaluaion will increase i's expors and reduce impors, hereby helping o improve he counry's rade balance. A he same ime, exchange rae also affecs a counry s overall economic siuaion hrough influencing i s capial inflows and official reserves (Cooer Riehard, 1971). Changes in exchange raes will firs affec a counry s foreign rade hrough he price and oher muliple funcion, finally making an impac on he price of non-rade goods in he counry. Currency devaluaion, for example, will boos expors and reduce impors, and resul in a rising price for impored goods a home, hus indirecly simulaing domesic prices. A he same ime, he price of impored raw maerials and equipmens will rise o lead a rise in prices for oher relevan commodiies. And hose rises will coninue o influence oher goods price such as he subsiues. Therefore, he rising of all his series price will gradually be exended o all goods. In addiion, exchange rae movemens will impac on a counry s naional income and employmen levels, oo(xiangsheng Dou, 2007). In a word, exchange rae changes will influence inernaional economy and a counry s foreign rade. The exchange rae flucion of major indusrial counries in he world can have a significan impac on inernaional economy and also oher counries' rade balance, which may increase rade fricion beween differen counries and affec counries normal economy and rade developmen. A he same ime, he exchange rae changes will affec he sabiliy of inernaional finance and he developmen of inernaional economy (Zouheir Abida, 2011). 3. A descripive analysis of RMB exchange rae and foreign rade 3.1. The volailiy of RMB nominal exchange rae Wih he developmen of economy, The Chinese governmen has loosen i s conrols on exchange rae, while China's exchange rae regime has gone hrough several significan ransformaion sages. Because he Unied Saes is he world's larges economic power, apar from he EU, he US is China s second larges rading parner. Alhough China has changed i s currency sysem from pegging he US dollar o pegging a baske of currencies, China sill uses he US dollar on he paymen in inernaional economy rade. Therefore, his paper uses available economic daes from 1981 o 2012 coming from he China Saisical Yearbook in 2012 o analyze he changes of RMB-US dollar exchange rae. As shown in Figure 1. he average RMB exchange rae is always flucuaing. During he period of , he dual exchange rae sysem was applied in China, and a his sage he RMB exchange rae was increased from o poin. In 1985, he governmen abolished he RMB inernal selemen price and hereby appeared a sharp depreciaion of RMB. In 1986, 1989 and 1990, China carried ou hree imes adjusmen for RMB exchange rae sysem, and in hose years he rae was reduced. Beween 1994 and 2005, he RMB exchange rae showed a seady rend, he exchange rae of RMB per $100 mainained a poin raios. In 1994, China implemened he managed 617

4 floaing exchange rae sysem which was mainly deermined by marke supply and demand. As a resul of his reform, as shown in Figure 1, in 1994 he exchange rae suddenly rose o poins, which caused high RMB Yuan devaluaion. Since hen, RMB exchange rae has remained a a relaively sable level. Even in 1997 afer he oubreak of Eas Asia's financial crisis, RMB Yuan showed a long-erm equilibrium rae. Since 2005, China has reformed he pegging sysem and implemened new sysem based on marke supply and demand, ha is, wih reference o a baske of currencies, a managed floaing exchange rae sysem. The exchange rae of RMB per $100 has showed a downward rend, and he raio were lower han 700 poin besides Changes in impor and expor volume A counry's economic saus is deermined by boh he domesic and he foreign economic condiion, he volume of impor and expor rade is an imporan indicaor o measure a counry's foreign economy. Through analyzing China s impor, expor and ohers, China's overall foreign economic siuaion can be known. According o specific impor and expor volume, he following figure 2 can be made, and i is an objecive descripion of China's foreign rade saes. As shown in Figure 2, China's foreign rade volume has been growing rapidly and seadily more han 20 years since Especially since 2000, China's foreign rade volume has showed a dramaic growh. In 1981, China's rade jus amouned o $44.03 billion and he expors and impors were only $22.01 billion and $22.02 billion respecively, bu by 2012 all of hem increased o $ billion, $ billion and $ billion respecively. Tha is o say, each year had a significanly increase. Furher more, beween 1981 and 2001, China's foreign rade volume showed a seady rise. Afer China joined he WTO in 2001, he foreign rade volume climbed rapidly, and in 2004 China s rade volume reached $ billion. Due o he global 618

5 financial crisis in 2008, boh expors and impors reduced sharply. However, since 2009 he foreign rade volume has presened a fas rising rend again, and China s economy is growing rapidly. Wih he developmen of China's foreign rade economy, China has become he world's bigges exporer since Empirical Analysis 4.1 Variables and daa This paper mainly o analyze he impac of exchange rae changes on he rade amoun of expor and impor. For he sake of simpliciy, o le E denoe he nominal exchange rae of RMB, X denoe he expors, and M denoe he impors. All sample daa including he nominal exchange rae, he impors and he expors are from 1981 o Due o various regular or irregular facors, here ofen appears a variey of flucuaions among ime series daa. In order o ge a beer regression sequence for exchange rae and rade daa, we firs conduc a logarihmic processing for all variables and hen do he uni roo es. 4.2 Uni roo ess This paper selecs he daes abou China s exchange rae, expors and impors from 1981 o To avoid non-saionary problem in ime series, here we use he uni roo es firsly, and he es resuls are shown in Table 1. As shown in Table 1, hose hree ime series for he expors (X ), he impors (M ) and he exchange rae (E ) are all firs difference saionary in he 1% level, showing ha hey are firsorder inegraion series. Asgain, we use co-inegraion es o see wheher here exiss a coinegraion relaionship beween hose series in he long erm. 619

6 4.3 Coinegraion es and equaion esimaion Supposing wo equaions as he following: lnx a1 a 2lnE u (1) lnm b1 b2lne v (2) Where, X denoes he expors, M denoes he impors, E denoes he RMB exchange rae, u and V denoes he equaion residuals of (1) and (2), respecively. Because expors (X ), impors (M ) and exchange rae (E ) are all firs order inegraion series, we can use he Engle-Granger es o see wheher here exiss co-inegraion relaion beween X E and M, and hen o make he regression for equaion (1) and (2), respecively. we use uni roo es o check he wo equaion s residuals, and he ADF es resuls are shown in Table 2. Table 1 he ADF es of impor, expor and exchange rae series Variables Tes Type ADF Value Criical value Tes Oucome M (c, 0, l) Non-saionary ΔM (c, 0, l) * Saionary X (c, 0, l) Non-saionary ΔX (c, 0, l) * Saionary E (0, 0, l) Non-saionary ΔE (0, 0, l) * Saionary Noe: In he (c,, l), c, and l presens he concep, rend and lag erm, respecively. *, ** and *** presens he es is saisically significan on he 10%, 5% and 1% level, respecively. Table 2 he ADF es of U and V series Residuals ADF Value 1% level 5% 10% u * v * Noe: *, ** and *** presens he es is saisically significan on he 10%, 5% and 1% level, respecively. 620

7 Table 2 shows ha u series is saisically significan on he 1% level, v is also saisically significan on he 1% level, so here exiss coinegraion relaionship beween lnx and lne and beween lnm and lne, which means here have long-erm sable relaionship beween exchange rae impors and expors. Therefore, we can build he following equaions: lnx R ( ) (6.1218) lne ,DW , F (3) lnm lne ( ) (5.8864) (4) 2 R ,DW , F From equaion (3), we see ha here exis a posiive long-run linear equilibrium relaion among China s expors and exchange rae. When he exchange rae rises, so does he expors; when he rae declines, expors decreased correspondingly. As we can seen from equaion (4), here exis a posiive long-run linear equilibrium relaion among China 's impors and exchange rae. However, he resul of he formula is opposie o he heoreical predicion. In fac, alhough he exchange rae plays an imporan role, many facors can cause changes in China's impor rade. Because he processing rade occupies a large par of China s expor and he raw maerials and inermediae goods of his kind of rade mosly depend on impor, he resul of growing expors will cerainly bring abou he growh of impors. In addiion, he developmen of China s economy and he increasing demand in he domesic marke will drive he growh of impors rade, oo. Due o hese facors, so since 2005, China s impors have been increasing fas wih he RMB s appreciaion. Therefore, oher facors excep exchange rae have greaer impac on impors. This is he main reason ha caused a posiive long-run linear equilibrium relaion among impors and exchange rae. 5. Conclusions and associaed policy suggesions Through he above analysis, his paper shows ha he RMB nominal exchange rae flucuaion is he main facor ha affecs China s impors and expors. In he long run, he rise of RMB exchange rae which means devaluaion of RMB will have a posiive effec on he foreign rade, and will also makes a significan growh on domesic impor and expor volume. Therefore, we mus ake effecive policies o adjus he relaionship beween RMB exchange rae flucuaions and foreign rade. 5.1 The coordinaion reform of exchange rae and ineres rae liberalizaion According o he ineres pariy heory, here exiss solid relaionship beween he ineres rae and he exchange rae, he ineres-rae spread of wo counries is approximaely equal o he difference beween he forward exchange rae and he spo exchange rae. The changes in ineres raes may indirecly affec he exchange rae level hrough influencing he currenaccoun and inernaional capial flows. On he conrary, exchange rae flucuaion may indirecly affec ineres raes level hrough influencing domesic price and shor-erm capialflow, hus here is a close link beween he wo. A managed floaing exchange rae sysem has been aken hrough China s exchange rae reform. In his case, if China sill uses cenralized managemen owards ineres rae, i will 621

8 inhibi he exchange rae s adjusing effec of economy and have a bad effec on China s paricipaion in inernaional economic cooperaion. In his background, China should gradually realize he marke-oriened reform of ineres rae o promoe he coordinaion beween ineres rae and exchange rae sysem, and o ake full advanage of he posiive effec of ineres rae. A he same ime, he foreign exchange markes are a par of financial marke sysem, hus China should coninue o improve financial sysem o make he foreign exchange marke more effecively (Zongxin Zhang, 2006). 5.2 The change in he expecaion of RMB appreciaion This paper finds ha in he long-run, he RMB exchange rae flucuaions have posiive effecs on relaed economic indicaors. However, in recen years because of huge rade surplus and vas inernaional reserve, China is facing grea pressure from he U.S., he Japan and oher European counries o upward revaluaion of he RMB and in he shor-erm he sharp appreciaion of he RMB will have an impac on China's economy. In recen years, expecaions are growing sronger for he RMB appreciaion, and he expecaion is going o ge worse. Under he pressure of RMB appreciaion expecaion, China mus ake measures o mainain a sable exchange rae, and coninue o change he hisory of he RMB pegging o a single currency o make he RMB exchange rae flucuaions more auonomously. In addiion, China needs o pay more aenion o he world economic crisis and o avoid oher counries o ake measures o shif is economic problems o China for heir own ineress. Taking ino accoun of oher economic facors and he inernaional environmen, China can gradually adjus he exchange rae and ake a moderae appreciaion of he RMB, and hereby adjus China's rade balance wih oher counries and ease foreign rade conradicions. A he same ime, he governmen should ake measures o opimize he expor srucure and change he exensive expor mode o achieve muually beneficial rade wih rading counries. Those acions may help o reduce he RMB appreciaion pressure from he America and oher counries and lower he expecaion of RMB appreciaion. 5.3 Gradually o open capial markes The economic inegraizaion developmen leads a higher mobiliy of inernaional capial especially in China, and his is an imporan facor ha caused he RMB exchange rae flucuaions. The rapid flows of capials affec China's exchange rae and hen indirecly affec money supply and he price level in China, and hereby have an impac on China s impor and expor rade. Therefore, China should gradually open he capial markes and pu more effors o crack down ho money inflows. When here is a seady expecaion of RMB appreciaion, we can use insiuional means o inensify he power o suppress and regulae he flow of ho money. Under he premise improving he managemen of he capial markes, in he shor-erm China need o open capial markes gradually, and ry o mainain he sabiliy of he RMB exchange rae level o guide he foreign capials o sar a orderly invesmen in China. In he long erm, he governmen should srenghen he regulaory role of he markes in he economy and go ahead wih reform and opening up, and he sabiliy and developmen of he capial markes will reduce he bad effec of ho money on economy. 5.4 The acceleraion of foreign exchange policy reform The diversificaion of reserve srucure In China, he governmen holds he majoriy of foreign exchange, and he US dollar is he main form of China's foreign exchange reserves. This single holding ways will affec he 622

9 independence of China s moneary policy, and may cause big reserve risks. Huge rade surplus and curren-accoun surplus for mang years are he direc cause of RMB appreciaion pressure. Accordingly, China should ake measures o opimize he foreign exchange reserve srucure (Magee and Grades, 2012). China can push he reformaion of foreign exchange sysem by using a diversificaion of foreign exchange reserves. Firsly, gold is relaively ideal invesmen due o is sabiliy in value, and i helps o avoid he invesmen risk. Therefore, China may increase he proporion of gold in reserves, which will help o srengh China's foreign exchange reserves. Secondly, China should reduce he proporion of he dollar in foreign exchange reserves and appropriaely increase he holding proporion of oher world currency, which may hereby enhance he capaciy of negaive impac of economic flucuaions. In addiion, in he process of rapid economic growh and srenghens of comprehensive naional srengh, China should acively and seadily ake effecive polices and measures o promoe he process of inernaionalizaion of he RMB, and his is an a-he-roo soluion o guaranee he securiy of China's foreign exchange and he auonomy of foreign exchange policy To increase holding proporion of individuals for foreign exchange Firsly, o increase he non-governmen holding proporions of foreign exchange will help o improve he sock srucure of foreign exchange. Secondly, he reform of foreign currency holding sysem will promoe a muliple sysem. All of hese can conribue o he diversificaion of foreign exchange holdings and invesmens and reduce he risks of China's foreign exchange reserves. In addiion, China needs o esablish a sysem o achieve i s srucural adjusmen of foreign exchange holding srucure o increase he holding proporion by he non-governmen. China should coninue o reform he exchange-rae regime and ry o reduce he expecaion of RMB appreciaion, and may ake measures by encouraging enerprises and privaes o use foreign exchange o do some raional invesmens, oo (Xiangsheng Dou, 2010). The governmen basically has achieved he markeizaion of foreign exchange ransacion, while he moneary policies have sill impacs on he exchange rae flucuaions. According o he economic pracices of all counries in he world, when a counry especially such as China is facing he complicaed financial markes, i need o combine moneary policy wih marke inervenion o improve he foreign exchange marke operaion mechanism To ransform foreign exchange reserves ino sraegic resource reserves From he real siuaion, China has high foreign exchange reserves and he governmen is eager o buy he reasuries from oher counries especially he U.S.. Therefore, he relevan counry's exchange rae policies or sysem reform will hreaen he safey of China s reserves o a cerain exen, which will resul in he reduce of foreign exchange reserve value. In order o insure he value of reserves, China should change he single form of invesmen o build a sraegic resources reserve sysem. China can use he available reserves o buy overseas sraegic resources such as oil, indusrial raw minerals and various non-renewable energy sources. This can no only help o reduce he huge foreign exchange reserves, bu also effecively ease he problems of resources, environmen and developmen in China s economy. A he same ime, China should urge privae enerprises o use he foreign exchange o increase heir foreign direc invesmen (FDI). China s privae enerprises occupy an imporan posiion in economic developmen, so he governmen should pay more aenion o hem o show heir grea vialiy and increase 623

10 heir foreign invesmen. All hose measures can grealy enhance and consolidae China's posiion in he world economy, and also help o promoe he implemenaion of China's "going global" sraegy (Xiangsheng Dou, 2010 ). Corresponding Auhor Wanhui Jiang, School of Public Adminisraion, Souhwes Jiaoong Universiy, P. R. China. E- mail: onlyjwhui@163.com. Address: School of Public Adminisraion, Souhwes Jiaoong Universiy, Jinniu, Chengdu , Sichuan, P. R. China. References 1. Chou W. L., Exchange Rae Variabiliy and China s Expors. Journal of Comparaive Economics, 28, CooPer Riehard, Currency Devaluaion in Developing Counries. New Haven: Yale Universiy Press,pp Valerie Cerra, Swea Chaman Saxena, An Empirical Analysis of China s Expor Behavior. IMF Working Paper, l,wp/02, pp Jaime Marquez, John W. Schindler, Exchange Rae Effecs on China s Trade: An Inerim Repor, he Inernaional Finance Discussion Papers, 86, pp Yue C., Hua P., Does Comparaive Advanage Explain Expor Paern in China?.China Economic Review, 13, Rose A., Yellen, Is here a J-curve. Journal of Moneary Economies, 1, Zouheir Abida, Real Exchange Rae Misalignmen and Economic Growh: An Empirical Sudy for he Maghreb Counries. Inernaional Journal of Economics and Finance, 5, Yulu Chen, Inernaional Finance. Beijing: China Renmin Universiy Press, pp. 29. (in Chinese) 9. Yang Cao, Jianwu Li, RMB real exchange rae and he impac of volailiy on expor rade-based on he years of empirical research. World Economy Research, 8, (in Chinese) 10. Xiaoyan Bai, The hisory and logic of RMB exchange rae sysem reform process. World Economic Research, 12, (in Chinese) 11. Xiangsheng Dou, Inernaional Finance. Beijing: Economic Science Press. (in Chinese) 12. Xiangsheng Dou, Researches on he Problem of he RMB Exchange Rae Sabiliy in he Conex of he Pos-financial Crisis Era. Pacific Journal, 18, (in Chinese) 13. Fuyou Li, Min Sun, An Empirical Sudy on he Effec of RMB Real Exchange Rae Change on Sino-Japan Trade from 2000 o Conemporary Economy of Japan, 2, (in Chinese) 14. Xiangqian Lu, Guoqiang Dai, The Influence of Flucuaion of Real RMB Exchange Rae o Chinese Impor and Expor: Economic Research, 5, (in Chinese) 15. Jie Ma, Can Zhang, DCC-GARCH-CVAR model and dynamic opimizaion he srucure of China's foreign exchange reserves. World Economy, 7, (in Chinese) 16. Weixian Wei, Analysis on relaionship beween China's expors and Effecive exchange rae. Saisical Research, 5, (in Chinese) 624

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