Renminbi Revaluation: Will Other Asian Currencies Follow?

Authors: Uri Dadush, Shimelse Ali
Originally published by the Carnegie Endowment for International Peace

Revaluation of the Chinese renminbi (RMB) is often cited as a necessary solution to the problem of global imbalances. In part, the argument goes, a RMB revaluation will lead other Asian countries to revalue as well. Indeed, the exchange rates of some Asian economies have tracked the RMB more closely in recent years.

However, such a widespread revaluation of Asian currencies is unlikely. While Asia’s middle-income countries—which compete with China in export markets—may move with the RMB, Asia’s advanced countries—which account for 45 percent of the region’s trade and whose exports complement those of China—are unlikely to follow the RMB’s path. In either case, any movement that occurs is unlikely to be large.

As a result, the effect of Asian currency movement on countries such as the United States—which competes more with advanced than with middle-income Asian economies—and on the most infamous global imbalances is likely to be limited.

The RMB’s increasing influence in Asia

Most Asian currencies have followed the U.S. dollar for decades—including the RMB, which was tightly pegged to the dollar until July 2005, when it began to liberalize. As China has allowed the RMB to appreciate against the dollar—first from July 2005 to August 2008 (when the financial crisis erupted) and again from June 2010 to the present (as the recovery took hold)—the RMB appears to be exerting independent influence on some Asian currencies, notably those in middle-income Asian economies.

For example, as shown in the figure below, during the RMB’s first period of reform (July 2005 to August 2008), the real effective exchange rates (REER)¹ of Malaysia, the Philippines, and Thailand—all middle-income economies—moved with the RMB. Their REER appreciated by 6 to 27 percent, compared to the RMB’s 13 percent real effective appreciation and in contrast to the dollar’s 10 percent depreciation. However, the REER of the advanced Asian economies―Japan, Hong Kong, and South Korea―which have similar exports to and compete more with the United States than the middle-income Asian economies do², moved against the RMB, depreciating by 12 to 17 percent over the period³.

Correlations Between the REER of Asian Currencies and the RMB and Dollar
	Before RMB Reform (August 2003-July 2005)		After RMB Reform (July 2005-August 2008)
	RMB	USD	RMB	USD
Advanced Asia
Singapore	0.88	0.89	0.79	-0.91
Hong Kong	0.93	0.97	-0.81	0.98
Japan	0.12	0.02	-0.58	0.65
South Korea	-0.58	-0.51	-0.76	0.69
Middle-income Asia
Malaysia	0.93	0.98	0.47	-0.52
Philippines	0.55	0.64	0.77	-0.90
Thailand	-0.04	-0.01	0.54	-0.75
Indonesia	0.34	0.39	-0.16	0.11
China	1.00	0.95	1.00	-0.84
Sources: BIS and authors’ calculations

Although disentangling the factors behind such movements would require deeper research, policy likely played a role. For example, Asian central banks appear to be increasingly including the RMB in the basket of currencies their exchange rates track, partly because of China’s rising weight in the region’s trade. Ito (2007) estimates that Indonesia and Malaysia now give the RMB a 45 percent weight in their basket (with the U.S. dollar, the euro, and the yen accounting for the other 55 percent)⁴.

Market forces are likely also responsible for the RMB’s rising influence. Studies show that rising speculation of RMB appreciation often leads Asian currencies to rise. And certain currencies—the Singapore dollar, for example—appear to serve as proxies for the RMB in futures markets.

Going forward, if the RMB continues to appreciate, it could affect other Asian currencies through three channels: relative prices, demand, and foreign investment. We explore each of these in turn.

Prices

Any RMB revaluation against the dollar will make Chinese goods more expensive abroad. As a result, countries that export close substitutes for Chinese goods—due to similar factor endowments, for example—will likely benefit from increased market share. Countries that export complements (e.g. parts and components) for Chinese goods, on the other hand, will almost certainly feel an adverse effect.

Middle-income Asian economies, such as Thailand, Malaysia, the Philippines, and Indonesia, appear to comprise the former group. Their export profiles—particularly those of countries with managed exchange-rate regimes—show large similarities with China’s (see chart below)⁵. And shifts in their shares of third markets suggest that the competition between them and China is growing. China’s share of Asia’s exports to the United States tripled from 14.5 percent in 2000 to 44 percent in 2008, while that of middle-income Asian economies fell from 15.2 percent to 11.5 percent over the same period⁶.

Net Export Similarity Index between China and Asian Countries
	1996	2008	Exchange Rate Regime
Thailand	43.6	35.3	Managed Float
Malaysia	21.7	30.9	Managed Float
Philippines	44.8	26.1	Float
Indonesia	31.6	19.0	Float
Singapore	10.1	15.8	Managed Float
Japan	10.6	14.9	Float
South Korea	22.2	25.1	Float
The index ranges from 0 to 100; 0 represents completely dissimilar export profiles between two countries, while 100 represents identical export profiles.
Sources: IMF and Locke (2009)

These countries may gain market share if the RMB revalues, which will eventually put pressure on them to appreciate their currencies as well. At the same time, some of these countries, including Indonesia and Vietnam, import more from China than they export there and will experience adverse effects from rising import prices. Therefore, the direction of the pressure on their currencies will depend on which effect is greater: the benefit from increased export market share or the cost of higher import prices from China.

As for China’s advanced neighbors—such as Japan, Korea, Hong Kong (China), and Singapore—a RMB revaluation will likely hurt their trade. Their export structures (controlling for trade in components) have little in common with China’s (see table above). Rather, the two complement each other: the advanced countries provide intermediate goods that China processes and re-exports. About 60 percent of intermediate goods in China come from other Asian countries, particularly the advanced economies. As a result, RMB revaluation could hurt the advanced Asian economies by slowing China’s export growth and thus lowering its imports from them.

Demand

RMB revaluation will also affect China’s growth, which in turn will impact the rest of Asia’s growth through reduced demand for consumer and intermediate-goods exports. A recent study shows that a 1 percent slowdown in China’s growth would lead to a 1.12 percent reduction in the growth rates of a sample of emerging economies, including Hong Kong, India, Indonesia, Malaysia, the Philippines, Singapore, and Thailand. A large RMB revaluation that sharply slowed China’s growth could therefore lead other Asian economies to suffer and put downward pressure on their real effective exchange rates.

Unless it were massive, however, a revaluation is unlikely to cause such a sharp slowdown. The RMB’s appreciation against the dollar from July 2005 to August 2008—nearly 7 percent annually—had little visible effect on China’s double-digit growth, for example. Similarly, a study by Deutsche Bank finds that a 10 percent RMB appreciation would reduce real GDP by only 0.6 percent from its baseline. More generally, studies find little evidence that countries that de-peg their currencies experience a durable growth slowdown as a result.

Moreover, China may well adopt other policy measures that stimulate domestic demand, such as renewed fiscal stimulus, to offset the RMB revaluation’s impact on growth. Thus, a gradual RMB revaluation would likely put little pressure on other Asian currencies through the demand linkage.

Diversion of FDI

Finally, a RMB appreciation could affect other Asian currencies through foreign direct investment (FDI). In recent years, China has not only become Asia’s trading powerhouse, it has also emerged as the preferred destination for FDI in the region. Reflecting its attractiveness to outside investors, China’s share of Asia’s FDI inflows rose from about 25 percent in 1992 to 37 percent in 2008, while other Asian economies with similar income levels and relatively cheap labor―Malaysia, Philippines, and Thailand―saw their share fall sharply over the same period.

Since a revaluation of the RMB may decrease China’s attractiveness as an investment destination, FDI flows may go instead to developing Asian economies. However, the profit margin of multinationals in China is reported to be robust and—given large fixed and transaction costs and investors’ tendency to reinvest profits—a shift in FDI is expected to be gradual.

Conclusion

Though the RMB’s influence in Asia is growing, a revaluation will affect the exchange rates of China’s advanced and middle-income neighbors differently, reflecting their various trade and investment relationships. With regard to the United States, as we have argued previously, the high degree of complementarity between its economy and those of China and Asian middle-income countries suggests that it will likely lose out from RMB revaluation as its import prices rise. As a result, the potential impact of RMB revaluation on the U.S. current account deficit is smaller than often assumed.

---

¹ We focus on the REER, rather than nominal exchange rates, because the former are the more appropriate indicators of changes in competiveness in international markets.

² A recent study by the Peterson Institute found that U.S. manufactured exports are more similar to those of developed Asian economies, such as Japan and South Korea, than they are to Asian developing countries, such as Indonesia, India, and Vietnam. China shows moderate similarity with U.S. exports.

³ In both cases, there were exceptions. Among the advanced countries, Singapore, often described as an entrepot economy, saw its dollar closely shadow the RMB, while Indonesia, a middle-income oil exporter, saw its rupiah move mildly against the RMB.

⁴ The dollar’s influence is not declining in every country, however; Hong Kong has maintained its parity against the dollar for twenty-five years.

⁵ Examining the net-export values of a product group can show whether an economy’s exports add value in that group.

⁶ Shifts at the industry level suggest more intense competition: China’s share of Asia’s exports to the United States increased in 44 of 47 industries, while that of the middle-income Asian economies fell in 34 of the 47 industries.