Literature Review

8.2 Literature Review

Assuming a significant third country effect, Hoggarth and Tong (2007) find that the positive effects of renminbi appreciation may not be that large. While its impact is expected to be weak on countries exporting consumer goods, it may have negative effects on countries supplying capital and intermediate goods.

Wei et al. (2000) examined the impact of a devaluation of the renminbi on the external sector of Hong Kong. The results show that the impact of currency devaluation would be negligible for Hong Kong’s foreign exchange reserve. There are some attempts to examine the extent of undervaluation in the renminbi.

Prasad (2009) argues that China has been pursuing protectionist policies by continuing with substantial undervaluation of exchange rate to maintain its competitive advantage in the international market. Recent Chinese monetary policies allowed the renminbi to appreciate since July 2005, but undervaluation in the currency remain until 2009. Undervaluation was weak in the first quarter of 2009, and this had an adverse impact on Chinese economy in the form of a sharp fall in the foreign exchange reserves, slowing down of capital inflows, and a declining trade surplus.

According to Tung and Baker (2004),the exchange rate regime in China is de-facto pegged to US dollar since the devaluation of RMB in 1994. Over a period, RMB is overvalued vis-à-vis US dollars and several other currencies globally. In the presence of deliberate policy of keeping RMB undervalued, it is argued in the paper that a one-time ‘maxi revaluation’ of around 15 per cent versus the US dollar could facilitate China to move towards a more flexible exchange rate regime. In another study, Dunaway and Li (2005) estimated the extent of undervaluation in the renminbi, ranging between 0 and 50 per cent.

57 China is strongly engaged with Africa in trade, investment and development assistance during the past decade. In case of revaluation of renminbi, loss of export market of China in Africa could be minimised

with other compensation mechanism such as investment and development aid (OSC, 2013).

Using quarterly trade data for the period 2000-10, Arunachalaramanam and Golait (2011) analysed the impact of appreciation of the renminbi on India’s bilateral trade

with China. The study estimated both bilateral export and import functions using least square and VECM models. Results show that the relative appreciation of the RMB with respect to rupee has a positive impact in favour of India in improving its market access in China and arresting its bilateral imports significantly. Moreover, bilateral exchange rate elasticity of imports was higher than exports, which is causing persistence of India’s bilateral trade deficit over a period.

To sum up, the exchange rate regime in China has evolved in a manner so as to support its external sectors to grow. Accumulated over the years, the renminbi has been kept undervalued in the range of 15-50 per cent vis-à-vis the US dollars and hence with many currencies in the world including the Indian rupee. There is global pressure for the revaluation of the RMB and China has initiated some measures in this direction. The implication of a one-time discrete devaluation is expected from the Chinese monetary authority. The implication of such an initiative could be a step forward in improving the export prospects of major trading partners of China, though some feel the impact could be mixed. While some countries expect to benefit from the RMB’s appreciation in terms of gaining market access in China and third countries, others paint a pessimistic scenario. India is expected to benefit from an appreciation of the renminbi in terms of improving its bilateral market access in China and also restraining the present level of unsustainable bilateral imports. The manner in which India would respond to improve its export profile in other major export destinations as a consequence of a revaluation of the Chinese renminbi, is an empirical question that needs to be addressed.