CIAO DATE: 2/00

Implications of RMB Devaluation

Julie Reinganum

November 3, 1998, New York

Speeches and Transcripts: 1998

Asia Society

 

Talking points from a speech in New York as part of the Autumn 1998 CEO Forum

Introduction

1. Yong Longtu and others now all say the RMB will not devalue (Zhu announced this to Charlene Barshevsky)
2. Last weeks Economist predicts “gloom and doom for China”
3. 3.Economist Vinnie Agrawal and Laurence Lau cannot not find any good reason for devaluing currency.
4. In looking at the devaluations of other Asian currencies in 1997–there was a “denial syndrome”—in Thailand and Indonesia, there were serious mismatches in assets and liabilties in the banking sector, which resulted in under capitalized, under regulated banks... and what we learned is that nations with basically sound macroeconomic fundamental can succumb to overvalued currencies and poorly managed financial institutions.

 

So, what is going to happen in China?

Today, my comments are going to briefly cover:

1. A historical perspective
2. Current perceptions—Has the RMB already devalued?
3. Some facts on the Chinese Economy
4. What would drive the decision to devalue
5. Potential Impact on the Chinese Economy
6. Impact on other Asian Economies—and the impact of devaluation of other currencies
7. The impact of devaluation of the RMB on business in general, and
8. The views of three individuals with whom I recently spoke in China, one from a Chinese publically listed company, one government economist and one from a MNC.

 

My Perspective

1. Until 1993 the Chinese currency floated. In 1979 it was about 1.5 RMB=1 dollar in the early 1990’s, on the black market, it was as high as 15
2. Until April 1, 1994 there were two exchange rates: the swap market and the official rate.
3. Until that time, exchanging RMB for FX was cumbersome. Currency exchanges through SAFE have been routine.
4. There is now an expectation of a stable exchange rate.

 

Others Perceptions

1. A devaluation of the RMB will lead to further devaluations of other Asian Currencies and cause a general crisis in the region.
2. A devaluation of the RMB would shatter confidence in the HK dollar.
3. A devaluation would not help exports (only 20% of the Chinese GDP—and they have declined this year due to a drop in demand from Asia)
4. China has already devalued the RMB due to restrictions on currecny converitbility.
5. Chinese government credibility hinges on maintaining the exchange rate.
6. A stable exchange rate will support Chinese entry into the WTO (the real question being asked now however, is does China want to enter the WTO—is an open capital account in China’s interest?)
7. Chinese unemployment and resulting labor unrest may force a devaluation.

 

Has The Rmb Already Been Devalued?

1. SAFE no. 27 effective 9/1/98—increases the amount of cash collateral required by buyers in the PRC to open L/Cs
2. Foreign banks have been notified that all new L/Cs, the issuing bank, the import–export company and the port location must be in the same city
3. SAFE No 50 issued 8/20/98—prohibits foreign companies from converting RMB to foreign currency in order to pay off foreign currency denominated debt before it matures
4. PRC ordered all PRC enterprises to repatriate FX held oversees
5. SETC imposed price controls on 21 goods in September. Many see this as a response to cost cutting relative to low price imports from other Asian countries.
6. Increase in the VAT rebate from 9 to 11%

 

The Facts

1. China has a closed capital account
2. China has substantial FX reserves –$140 billion
3. China’s external debt is only $130 billion and is staggered in payment due dates—85% is long term.
4. China has a large current account surplus of US$22.6 billion in the first half of 1998
5. China’s economy continues to grow (albeit at slower rates)
6. China has committed the equivalent of 3.5% of the GDP to infrastructure investment.
7. Domestic savings in China has remained high 35–40% of GDP
8. Foreign Direct Investment in China has dropped—but it only accounts for 10% of the GDP.
9. Chinese labor rates are lower than those in the rest of SE Asia.

 

What would move the decision to formally devalue?

1. Excess domestic capacity
2. Unemployment
3. Political instability
4. Inability to maintain reasonable level of exports
5. Inability to attract FX.
6. A decision by Beijing leadership that devaluation is in China’s best interest

 

Potential Impact of Devaluation for the Chinese Economy

1. Raise the cost of oil imports
2. Spur exports
3. Reduce foreign investment
4. Increased infrastructure investment—numbers like $750 billion (Li Lanqing) and US$1.2 trillion (Wu Yi)

 

The Potential Impact of Devaluation on Business

Impact of other currency devaluations on business has been dramatic

• IMF intervention
• Loss of infrastructure business
• Layoffs (negative earnings IR example)
• Unemployment
• Political instability
• Did not increase exports significantly?
• Did not reduce Chinese exports since they deal in different products. More limited financing options in China. Japanese, Korean, and SE Asian banks pulled out of the market.

1. Impact of RMB devaluation

• Reduces the cost of RMB loans used by consumer product companies
• Increases the amount that can be bought for investment
• Reduces the amount of earnings repatriated
• Increases the attractiveness of RMB loans
• Increases the need to source locally for JV production that is not re–exported
• Potential inconvertibility of currency—need to do barter or other trade arrangements
• Potential tightening of contract commitments for exports to JV’s where things have been lax over the past few years.
• 54% of imports go into exports, therefore it would decrease export competitiveness

The View of a Chinese Public Company—Hai’er—publically listed, exports worldwide, offshore manufacturing in SE Asia, and eastern europe, plans to set up plants in Mexco & U.S.

1. Will impact price of products sold in PRC because of imported components.
2. Will not impact offshore price
3. Sharper competition ininternational markets in SE Asia
4. Currently taking advantage of depreciation of Won in Korea by expanded advertising campaign
5. Want to settled non–RMB denominated debt early
6. Believe that in June 1999 may be devaluation–but not significantly

The View of a Chinese Economist

1. Devaluation does not serve the Chinese economy—especially if one looks at the impact of imports and exports
2. Growth rate of PRC exports has not dorpped due to lack of compeititveness, but rather due to lack of purchasing power of SE Asian countries.
3. Devaluation of the Yen does put pressure on the RMB to devalue
4. Key issue is not RMB devaluation, but whether or not Asian economic downturn will lead to global recession
5. Key issue which could force devaluation would be unemployment (according to FEER as much as 150 million)
6. Non performing loans. As recently as two weeks ago the default of GITIC. Loans between 1978–1997 experienced 40 fold increase to 7.5 trillion RMB or $906 billion—equal to China’s GDP. Non performing loans are about 25% up from 20% in 1994.

• 6/21/98 Beijing closed Hainan Development Bank
• Then days later, Venturetech
• Now, GITIC

The view of a Foreign Company

1. Negative affect on import
2. Positive effect on exports
3. Believe that will devalue about 5%
4. Will force foreign companies to invest in local economy in order to protect against devalations
5. Most JV’s will be hard hit because most JVs import a lot of intermediate products

Thank you.