Chinese trade price and Yuan's valuation

• Author: Qi Li,Li Gan,Yichen Gao
• Published date: 01 July 2019
• DOI: http://doi.org/10.1111/twec.12752
• Date: 01 July 2019

ORIGINAL ARTICLE

Chinese trade price and Yuan's valuation

Yichen Gao

1

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Li Gan

2

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Qi Li

2

1

International School of Economics and Management, Capital University of Economics and Business, Beijing, China

2

Department of Economics, Texas A&M University, College Station, Texas, USA

Funding Information

National Natural Science Foundation of China, Grant/Award Number: 71501133, 71601130

KEYWORDS

Chinese yuan, currency valuation, exchange rate, external trade, purchasing power parity

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INTRODUCTION

Effective from 1 October 2016, the Chinese yuan or Renminbi (RMB) was finally adopted into the

special drawing rights (SDR) of the International Monetary Fund (IMF), which was a result of the

rapid internationalisation of the Renminbi (Frankel, 2011). The yuan has shown its importance as a n

international anchor currency. People's Bank of China (PBOC), the Chinese central bank, let the yuan

fluctuate freely against a basket of currencies within a trading band since August 2015. Allowing the

currency system to be more flexible is a big step in the reform of Chinese exchange rate policy.

Historically, Chinese exchange rate policy has been modified several times since 1981. The

yuan depreciated from 1.8 per US dollar in 1981 to 8.28 per US dollar in 1994. From 1985 to

1994, China had a dual exchange rate policy (swap exchange rate) to encourage exports and limit

imports. From 1994 to 2005, the official exchange rate stabilised at a single conventional pegged

exchange rate regime. During this period, one Chinese yuan was pegged to 8.28 US dollars. The

yuan was still pegged to the dollar after the 1997 Asian financial crisis, while many southeastern

Asian countries (Indonesia, Malaysia, South Korea, Philippine and Thailand) were forced to switch

to a floating exchange rate policy. In December 2001, China finally acceded to the World Trade

Organization (WTO), thanks to the efforts made by the Chinese government. China agreed to grad-

ually reform its exchange rate policy after joining WTO. On 21 July 2005, China's authorities

increased the flexibility in its currency system by allowing yuan managed float against a basket of

currencies, instead of solely pegged to the US dollar. Due to the 2008 global financial crisis, the

yuan was pegged to the US dollar again to avoid sudden appreciation ($1 = ¥6.83 from July

2008). At the end of 2008, China spent four trillion yuan (about S$586 billion) to boost China’

economy and minimise the impact of the crisis. PBOC restarted yuan's managed floating exchange

rate policy on 19 June 2010. On 11 August 2015, China devalued the yuan by about 1.9%. Fig-

ure 1 shows the yuan's nominal exchange rate against the US dollar from January 1989 to Decem-

ber 2015 with each critical date of major economic events indicated by a dashed line. In recent

years, China's authorities gradually increased the flexibility in its exchange rate regime.

Many researchers believed that the Chinese yuan was undervalued during the period when the

yuan was pegged to US dollar. Wagner (2011) believed that China could not continue to keep the

value of yuan artificially low if it hopes to becom e the world's dominant economic power. Frankel

Received: 28 January 2018

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Revised: 21 October 2018

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Accepted: 27 October 2018

DOI: 10.1111/twec.12752

World Econ. 2019;42:2215–2243. wileyonlinelibrary.com/journal/twec © 2018 John Wiley & Sons Ltd

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(2011) suggested China allow the RMB to appreciate in order to internationalise it. Jo, Chiongbian,

Fremd, Kholiya, and Sethu (2010) suggest that yuan was undervalued after July 2008. The perfor-

mance of the reform of Chinese exchange rate policy and the concern about the yuan's undervaluation

drive us to study how the major economic events would have affected the yuan's nominal exchange

rate against the US dollar from 1989 to 2013. These events include the following: (i) the start of

China's pegged exchange rate regime in January 1994; (ii) China's accession to World Trade

Organization (WTO) in December 2001; (iii) the reform of Chinese exchange rate policy in July

2005; (iv) China's economy stimulus package in November 2008; and (v) restart of Chinese exchange

rate policy reform in June 2010. Due to data limitation, we leave the policy reform in August 2015

and yuan adopted to SDR in October 2016 for future study. By comparing these counterfactual

exchange rates and the yuan's actual nominal exchange rates, we can infer the magnitude of under or

overvaluation caused by each major economic event and the yuan's pegged exchange rate policy.

The traditional methods of estimating average treatment effect, such as the usual difference‐in‐

differences (DID), fail since Chinese yuan was a fixed number during most of our targeted period

and should not be used as a dependent variable in any regression analysis. We develop a new esti-

mation strategy by combining a novel panel data method proposed by Hsiao, Ching and Wan

(2012, HCW) and the purchasing power parity (PPP) theory to bypass this problem. HCW (2012)

exploited the dependence of Hong Kong annual real GDP among different countries and con-

structed the counterfactuals using data from countries without the treatment of “political and econ-

omic integration of Hong Kong with mainland China.”Using HCW's methodology, Bai, Li, and

Ouyang (2014) (BLO) constructed counterfactual home prices in the absence of property taxation

for Shanghai and Chongqing. Using linear projection theory, Li and Bell (2017) showed that

HCW are robust to regression functional form mis‐specification. Our problem is more difficult than

108642

1994m1

1997m7

2001m12

2005m7

2008m11

2010m6

FIGURE 1 Chinese Yuan's nominal exchange rate against US dollar (January 1989–December 2015)

Notes: This graph plots the yuan's nominal exchange rate against the US dollar from January 1989 to

December 2015. The data are from International Financial Statistics (IFS) of International Monetary Fund

(IMF). Dashed lines indicates all related months of major economic events, among which we study five

events—January 1994 (1994m1), December 2001 (2001m12), July 2005 (2005m7), November 2008

(2008m11) and June 2010 (2010m6).

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