Chapter 10. The Impact of the Exchange Rate
10.3 Effect of the RMB Appreciation on General Trade
An exchange rate appreciation generally causes a decrease in trade surplus or an increase in trade deficit. Although this conclusion is applicable to most countries in the world, it is not necessarily correct in the discussion of China’s foreign trade. Although general trade is highlighted in most countries in the world, processing trade accounts for a large proportion in China. In 2014, the imports and exports of China’s general trade totaled $2.3 trillion, and the imports and exports of processing trade totaled $1.4 trillion. The latter accounted for 32.7% of the total trade volume. In 2014, the proportion of pro- cessing trade to total exports of the manufacturing industry was as high as 39.6%. A surplus of $92.9 billion was recorded in general trade and a surplus of $358.8 billion in processing trade.2 The most of the trade surpluses were from processing trade. As the effects of the exchange rate adjustment on general trade and processing trade are different, the influence of such adjustment on China’s import and export has obvious particularity.
With economic globalization, the division of labor in modern production is no longer a comprehensive division of labor at the national level but a specialized division of labor in departmental and enterprise levels, which distributes the value chain combinations of products all over the world when forming an international produc- tion network system. China deserves to become an important link in the global production chain. According to the research of Koopman et al. (2008), approximately 37.2% of the added value of exports from China is created in foreign countries, and the proportion reaches over 80% in the exports of information, electronics, and other high-tech products.
2Source:People’s Daily, January 11, 2012. Similar to that in China, Mexico’s processing trade also accounts for a large proportion. See Table 10.5 for details.
316 From Trade Surplus to the Dispute over the Exchange Rate
Table 10.5: Proportion of processing import and export to total imports and exports in manufacturing industries in China (%).
Proportion of processing trade export to total exports
in manufacturing industries
Proportion of processing trade import to total imports
in manufacturing industries
1993 58.9 40.5
1994 56.2 47.9
1995 57.9 54.2
1996 65.3 54.9
1997 62.7 61.8
1998 63.9 58.4
1999 63.3 53.0
2000 61.5 51.9
2001 61.4 47.5
2002 60.6 49.7
2003 59.9 47.9
2004 59.3 50.0
2005 58.4 53.5
2006 55.7 53.2
2007 53.4 51.7
2008 50.0 49.1
2009 51.5 45.0
2010 49.5 43.4
2011 46.5 41.2
2012 44.3 40.7
2013 40.9 38.5
2014 39.6 40.0
Source: CEInet database.
In Europe and the U.S., the exchange rate adjustment affects only general trade imports and exports, but in China, the situation is different. The exchange rate adjustment affects four aspects, namely, the import and export of general trade and the import and export of processing trade (Fig. 10.2).3
The exchange rate appreciation has different effects on different departments and ways of trade.
3Mexico’s processing trade also accounts for a large proportion. In 2006, its processing trade exports and imports accounted for 85.4% and 52.7% of total exports and total imports, respectively, both higher than those of China (52% and 40.6%).
The Impact of the Exchange Rate Adjustment on Import and Export 317
RMB Exchange Rate Appreciation
Export Price Rises in USD Import Price Drops in RMB
Relative Price of Import Drops
Trade Surplus (?) Relative Price of Export Rises
Demand for General Trade Export Drops Demand for General Trade
Import Rises
Processing Trade Import
Rises
Processing Trade Export
Rises
Figure 10.2: Effect RMB appreciation on trade balance.
Notes: In the figure, (−) means that the RMB appreciation has a negative effect on the trade surplus; (+) means that it has a positive effect on the trade surplus;
(?) means the trade surplus trend is uncertain.
Generally, the RMB appreciation causes imports to rise and exports to drop in general trade. In processing trade, after the exchange rate appreciation, the prices of imported raw materials and spare parts drop. If the products can still be exported at their orig- inal prices (in RMB), the enterprises will make more profits; if the exports are affected because of the rising prices, the enterprises will have room to reduce prices while maintaining the original profits.
The RMB appreciation causes the general trade surplus to decrease and the processing trade surplus to increase. In fact, it promotes the development of processing trade. As a large number of multinational companies build factories in China, the exports processing trade has increased significantly, accounting for almost half of China’s foreign trade exports. The negative effect of RMB appreciation on general trade is largely offset by processing trade.
The increase or decrease in trade surplus after RMB appreci- ation depends on the proportion of processing trade in different departments. In foreign trade, which is primarily inter-industry trade, the rising export prices lead to a decline in external demand
318 From Trade Surplus to the Dispute over the Exchange Rate
after RMB appreciation. Imports will also increase to replace domes- tic products, resulting in the shrinkage of domestic production. In foreign trade that is primarily intra-industry trade, the impact of the RMB appreciation on the domestic economy depends on the added value of imports and exports. Even if the currency appre- ciates, the range of increase in the price of the export products depends on the proportion of the domestic added value. A lower proportion means less effect of the RMB appreciation on exports.
After an exchange rate appreciation, the trade surplus decreases in departments where processing trade accounts for a small proportion and decreases slightly or increases in departments where processing trade accounts for a large proportion. Such phenomenon is inconsis- tent with the people’s general understanding. Therefore, aside from observing the change in total volume, the different departments and different products (distinguished according to their proportions of processing trade and science and technology content) should be dis- cussed separately when studying the relationship between exchange rate adjustment and trade surplus.
Since the exchange rate reform in 2005, the general trade sur- plus has dropped and the processing trade surplus has risen. After September 2009, all trade surpluses in China came from processing trade and general trade deficits became common. The general trade deficit lasted for 22 months, increasing from $2.684 billion in Septem- ber 2009 to $57.983 billion in June 2011, an increase of over 114%. At the same time, the processing trade surplus did not decrease with the appreciation of the RMB exchange rate. After eliminating the sea- sonal factors, the processing trade surplus increased annually, from
$23.19 billion in July 2005 to $164.25 billion in June 2011, a monthly average increase of over 18%.
In January and June 2011, the exchange rate increased by 4.7%
over the same period last year; the processing trade surplus con- tinued to increase by 21.4% and the general trade deficit increased by 69%. After offsetting, the absolute value of China’s surplus was reduced by $339 million over the same period last year, down by 2.06% (Table 10.6).
The Impact of the Exchange Rate Adjustment on Import and Export 319
Table 10.6: Effect of the RMB appreciation on processing trade and general trade.
Period-end USD exchange rate (June)
Gap between imports and exports
of processing trade ($100
million)
Gap between imports and exports
of general trade ($100
million)
Total surplus
($100 million)
2010.01–06 6.79 4571.06 −1507.67 3063.39
2011.01–06 6.47 5549.55 −2549.24 3000.31 Rate of Exchange (%) −4.70 21.41 −69.08 −2.06 Source: CEInet database.
This law is also reflected in the trade relationship between China and the U.S. Since the exchange rate reform in 2005, with the contin- uous appreciation of the RMB against the USD, China has increased its import of U.S. goods. The growth in China’s general trade import of U.S. products was most significant, increasing by 30.4%; process- ing trade imports also increased by 21.1%. China’s general trade exports to the U.S. increased by 20.7% and processing trade exports by 34.5% over the previous year. After the subprime crisis, U.S. con- sumers increased their demand for cheap products made in China.
In 2007 and 2008, China’s consumer product exports to the U.S.
increased by 15.7% and 5.4%, respectively, and exports of processing trade increased by 12.4% and 15.0%, respectively. In 2009, a worse financial crisis set back the entire U.S. economy. The U.S. demand for products made in China dropped shortly and then recovered in the following year. In 2010, China’s general trade exports to the U.S. increased by 73.9% and its processing trade export to the U.S.
increased by 68.1% (Table 10.7).
The effect of the RMB appreciation on different industrial depart- ments can be clearly observed through the CGE simulation. The real RMB exchange rate appreciation reduces the general trade surplus and brings different effects on different departments in processing
320 From Trade Surplus to the Dispute over the Exchange Rate
Table 10.7: Average annual rate of change in the imports and exports of con- sumer goods and manufactured goods in the Sino-U.S. trade (%).
China’s imports of final goods from the U.S.
China’s imports of processing goods from the
U.S.
China’s exports of final goods to
the U.S.
China’s exports of processing goods to the
U.S.
1997 −13.8 9.5 22.1 25.5
1998 9.4 11.1 15.2 23.3
1999 18.7 14.8 10.5 14.0
2000 18.9 7.5 22.5 24.9
2001 29.0 11.9 3.3 9.8
2002 −0.8 8.5 29.3 27.7
2003 8.7 24.9 32.9 30.5
2004 17.6 33.8 31.9 46.1
2005 7.8 15.7 29.6 33.3
2006 30.4 21.1 20.7 34.5
2007 11.9 18.6 15.7 12.4
2008 8.0 12.9 5.4 15.0
2009 −1.5 −7.7 −6.4 −26.1
2010 −0.3 17.1 73.9 68.1
Source: UN COMTRAD. Manufactured goods and consumer goods are classified accord- ing to BEC.
trade. For example, the RMB appreciation significantly affects the exports of departments highlighting general trade, such as clothing, leather, wood products, and paper products, thus leading to a decline in surplus. However, the surplus reduction of departments such as transport equipment manufacturing, machinery manufacturing, and electronics manufacturing industries is mainly caused by the prices of import products falling with the appreciation of the home currency.
The increase in domestic demand for imports reduces the trade sur- plus of these departments.
According to the CGE simulation results, an increase in the real RMB exchange rate decreases the total exports in China’s general trade and processing trade, as measured by different degrees of phys- ical output. The decreasing extent of the exports of general trade is greater than that of processing trade. For example, an appreciation of the real exchange rate by 1% causes the total exports of general trade to decrease by 0.66% and the total exports of processing trade
The Impact of the Exchange Rate Adjustment on Import and Export 321
by only 0.14%. When the real exchange rate appreciates by 20% once, the total exports in China’s general trade and processing trade are significantly reduced by 14.07% and 3.22%, respectively (Table 10.8).
When the RMB appreciates by 1%, 2%, 5%, 10%, 15%, and 20%, the physical imports of China’s general trade increase by 0.34%, 0.69%, 1.77%, 3.71%, 5.83%, and 8.17%, respectively, and those of processing trade increase by 0.15%, 0.31%, 0.78%, 1.62%, 2.5%, and 3.45%, respectively. Clearly, the effect of the exchange rate appre- ciation is significantly higher on general trade than on processing trade.