GPAC The Impact of Appreciation of. RMB - Foreign Direct. Investment. Group 4. 國貿四 Patience 國貿三 Jason 國貿三 Archy 國貿二

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1 GPAC 2012 The Impact of Appreciation of RMB - Foreign Direct Investment Group 4 國貿四 Patience 國貿三 國貿三 國貿二 Jason Archy Alice

2 I. Introduction China, which is a contrary that has a significant impact on the world economy, started processing the 12th five-year project from2011, turning the policy goal into expanding export to increasing domestic demand, and fiscal expenditure. In 2005, China changed the exchange rate system to Managed Floating Rate System. All of those above mentioned policies did cause appreciation of RMB. According to the people bank of China, the current exchange rate of RMB is 1 USD to 6.31.Compared to the exchange rate in July 2005, which was 1 USD to 8.31 RMB. The growth rate is up to 25%. Furthermore, China's current account surplus has surged to record levels, fueling speculation that the currency needs to appreciate even further. Therefore, China is now facing the pressure form United States and other western countries. To emphasize how important China s economy is, tons of surveys and analysis are conducted in order to verify the world-known truth. We selected two surveys for example.

3 First, a recent survey of transnational corporations found that companies see China as the world s most important destinations for foreign direct investment. The World Prospectus Survey was released by the United Nations Conference on Trade and Development (UNCTAD), showing that China has once again retained title of the world s most important FDI destination. Second, is the statistical analysis about the number of times that the country is mentioned as a top priority for FDI by transnational corporations? The figure below shows the top priority host economies for FDI for the 2010 to 2012 period (the number of times that the country is mentioned as a top priority for FDI by transnational corporations). The number in parenthesis is the country s rank in last year s UNCTAD

4 survey. The figure below shows prospects for respondent companies FDI expenditures in 2010 to 2012 as compared to 2009 by home region: 1. Indicating an increase of less than 10 Percent; 2. indicating an increase between 10Percent and 30 percent; 3. indicating an increase between 30 Percent and 50 percent; 4. indicating an increase of more than 50 percent. Since China s economy is so influential to the world, China is such a important FDI inflows country, and the exchange rate is the core element for international trade and world economy, we are curious whether FDI

5 influences exchange rate. So the aim of our research is to find out whether FDI influences exchange rate for China. II. Literature Review Eichengreen and Tong (2011) in the research of IMF pointed out the impact which the appreciation of RMB can make. China exports a wide range of final goods. Foreign firms competing with Chinese exporters of these products will therefore take advantage from a change in policy which signals Chinese willingness to allow the RMB to appreciate. Similarly, China is increasingly important as a source of materials and components for manufacturing in lots of countries and industries. Firms relying on these inputs will therefore be negatively affected by RMB appreciation that makes those inputs more expensive. The importance of FDI (Foreign Direct Investment) can t be ignored in the world now. The direct influence from FDI includes the accumulation of capital, the increase of employment rate, and the industry chain effect. Wang (2007) indicated that the amount of FDI in fixed capital reached $832.6 billion in 2005 in China, which was 10% in gross

6 amount of fixed capital. Industry structure was also improved because of FDI in China. Since 1990, the proportion of foreign investment in labor intensive industry, high technology industry, and service industry was dramatically increased, which help transforming the industry structure in China. And about the characteristics of China s currency appreciation, Jiang (2010) pointed out that China was forced to strengthen its own currency because of the huge Trade surplus to U.S. and the imbalance of world economy. During the process of currency appreciation, China encountered accusation of dumping and subsidy, mostly from the U.S. Furthermore, U.S. Congress also passed relative acts to deal with its undervalued currency and trade surplus to U.S, such as the Schumer Bill in As for the correlation of FDI and exchange rate, several scholars had discussed about it before. Dewenter (1995) used the data of U.S. enterprises merger and acquisition activities to do the empirical analysis, and the result showed that FDI and exchange rate were positively related. Campa (1993) believed that multinational company s FDI policy is based on the expected value of its future profit, the more strengthened the

7 currency of a country is, the more expected value of its future profit will be (if entering the country). That is, he argued that FDI and exchange rate is negatively related. Cushman (1985) built a model of company s foreign investment. Through comparing four business-running modes of the model, he argued that the relation of FDI and exchange rate remained uncertain. III. Hypotheses There are three main hypotheses in our research. The first one is positive relationship between exchange rate and FDI. The second one is negative relationship, and the last one is no relationship. 1. Positive Relationship When a country s currency appreciates, consumers can spend less to buy same products in other countries. So, the consumers are more willing to invest in other countries. According to this, companies in other countries spending will increase, and FDI inflows to other countries will also increase. This is the positive relationship between exchange rate and FDI.

8 2. Negative Relationship When a country s currency appreciates and the businessmen need to retrieve their money, they may get less money back. Because the businessmen expected that they will get less money back, they are not so willing to invest in other countries. So, FDI inflows to other countries decrease. This is the negative relationship between exchange rate and FDI. 3. No Relationship There may be some reasons that exchange rate and FDI have no relationship. One is that a country has no interest in another country. Take bananas for example, if consumers in a country is more willing to purchase the bananas they planted by themselves, they won t purchase the bananas of other countries even if the price is cheaper. So there is no relationship between exchange rate and FDI. Difference of industrial structure may cause the result. For example, when a country puts emphasis on service industry and another country emphasizes on fishing industry. Businessmen in each country may not

9 invest in the other country. IV. Methodology According to the yearly date released from Ministry of Commerce of the People s Republic of China, in the end of 2011, the top five countries of direct investment in China are Hong Kong ( billion dollars), Taiwan (6.727 billion dollars), Japan (6.348 billion dollars), Singapore (6.328 billion dollars), United State (2.995 billion dollars), Korea (2.551 billion dollars) and United Kingdom (1.61 billion dollars). The statistic shows tremendous influence of FDI outflow from Hong Kong, Taiwan, Japan and Singapore to China. Considering the data availability, we would like to choose Taiwan, Japan, and Korea as our research samples to see the relationship between appreciation of RMB with direct investment from those countries to China. Based on previously statement, variables we are going to use are real exchange rate of RMB and FDI of China. In addition, because the research from Sun & Tong (2002) and Pan (2003) pointed out that Wage Level (which is on behalf of the labor cost) have significant explanatory power on FDI,therefore, we add Real Wage Level of China to our model.

10 TheFDI of China is the explained variables, other variables are explanatory variable. Also, we would like to use the form of natural logarithm to eliminate the heteroscedasticity that may happen in a sequence of variables. The model can be explained by following equation: LnFDIt=β 1 LnRERt+β 2 LnRWt+εt RER = EP/P*, where P is local price level, P* is foreign price level. And ε is the error term. After figuring out the LnRERt, we would use the multi regression to test the correlation of FDI and exchange rate. V. Result and Conclusion After running the model, we obtain the following results for Taiwan, Japan, and Korea s FDI to China, respectively: β1 β2 P Value of β1 Standard Error Taiwan Japan Korea For Taiwan s result, it shows that every unit of LnRER changing will lead to the decrease of 2.24 unit of LnFDI. As for Japan s result,

11 it shows that every unit of LnRER changing will lead to the decrease of 2.24 unit of LnFDI. These two countries prove that the hypothesis of positive relationship is valid, which means that when Taiwanese Dollar or Japanese Yen appreciate against RMB, their companies in China will increase the spending and finally lead to the increase of FDI to China. However, the outcome of Korea s part reveals a totally different result. We just found out that its P value of β2 is 0.19, larger than 0.1, which means there is no significance. That is, through the model we set up, we don t know whether there is positive or negative relationship for Korea Won s exchange rate to RMB- there might be NO relationship between Korean Won s exchange rate to RMB and Korea s FDI to China. According to the research released from Seoul International Financial Center in May 2012, the no - relationship of investment from Korea to China can be concluded by factors below: 1. China industry structure is changing rapidly Since the economic reform in 1978, China has become the most influential country in the world. With the rapid growing in manufacturing industry, China is called World Factory. In recent years, the industry structure in China is now changing from

12 manufacturing industry to service industry. China government also makes a lot of effort in flourishing local service industry. But 77.4% of FDI from Korea to China flowed to manufacturing industry in The research said, the changing of China industry structure led to the decrease of Korea FDI to China by averaged 5.4%. 2. Industries which Korea values in FDI Mining billion USD (45.8%), manufacturing 10.1 billion USD (22.7%), those two industries take the biggest part in the Korea global FDI. According the research of Seoul International Financial Center, the restrictions of mining and manufacturing industries in China are different from before. That is one of the reason why Korea FDI to China is decreasing. The restriction of our research Firstly, to make our analysis easier and more smoothly, we only choose two independent variables, the natural logarithm form of GDP and Real Exchange Rate. However, in reality, there are far more variables that

13 might affect the relationship between exchange rate and FDI. Secondly, we only chose Taiwan, Japan, Korea as our samples. If we added other countries like North and South American countries or European countries to our samples, the result can be different because the political and economic relationship between Western countries and China are much more complicated. VI. Data Sources 1. Ministry of Commerce of the People s Republic of China, The statistics of Foreign Direct Investment 2. Japan External Trade Organization (JETRO), Japanese Trade and Investment Statistics 3. US Department of Treasury, Resource Center, Data and Chart 4. International Monetary Fund, Data and Statistics, World Economic Outlook 5. International Monetary Fund, Data and Statistics, Regional Economic Outlook, Asia and Pacific 6. International Monetary Fund, Transcript of a Press Briefing by the IMF Asia Pacific Department

14 7. International Monetary Fund, IMF's International Monetary and Financial Committee Reviews Multilateral Consultation 8. Seoul International Financial Center VII. References 1. Ohno, Kenichi, 2011, Economic Development of Japan, National Graduate Institute for Policy Studies. 2. Barry Eichengreen and Hui Tong, 2011, The External Impact of China's Exchange Rate Policy: Evidence from Firm Level Data, IMF Working Paper 3. Campa, J.M., 1993, Entry by Foreign Firms in the United States under Uncertainty, Review of Economics and Statistics, Vol. LXXV, p Cushman K., 1985, Real exchange rate risk, expectations, and the level of direct investment, Review of Economics and Statistics, 1985, 67(2): Dewenter, K.L., 1995, Does the Market React Differently to Domestic and Foreign Takeover Announcements? Evidence from the U.S. Chemical and Retail Industries, Journal of Financial Economics, Vol. 37, pp

15 6. Yigang Pan, 2003, The inflow of foreign direct investment to China: the impact of country-specific factors, Journal of Business Research, Volume 56, Issue 10, pp 姜色色 (2010), 日元升值探究對人民幣匯率改革的啟示, 東北財經大學經濟學研究所碩士論文 8. 吳孟道 (2010), 日元升值探究對人民幣匯率改革的啟示, 財團法人國家政策研究基金會國政分析, 財金 ( 析 ) 號 9. 彭蘭 (2010), 人民幣升值對廣東 FDI 影響的研究, 廣東暨南大學經濟學研究所碩士論文 10. 王文武 (2007), 人民幣升值對我國利用外商直接投資的影響分析, 蘭州大學碩士論文