IMF Annual Conference

1. IMF Annual Conference Is The World Overvaluing the Renminbi Undervaluation?

2. IMF Annual Conference Honored Guests: IMF Representative: Mr. Emile Strauss-Kahn US Fed Representative: Mr. Juan Bernanke PBC Representative: Mr. Mario Xiaochuan

3. China Conference Main Topics: China�s Economic Overview Renminbi effect on the Current Account Trade Balance: What are the effects of the Renminbi? Relation with Trade Partners The Dilemma over China�s reserves Trade-off: Fixed Yuan vs. Floating Yuan Renminbi: a possible Global Currency?

4. Economic Overview China's economy during the last quarter century has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy. Major Reforms: Fiscal decentralization Increased autonomy for state enterprises Foundation of a diversified banking system Development of stock markets Rapid growth of the non-state sector Openness to foreign trade and investment

5. Economic Overview Measured on a purchasing power parity (PPP) basis, China in 2006 stood as the second-largest economy in the world after the US, although in per capita terms the country is still lower middle-income and 130 million Chinese fall below international poverty lines.

6. Economic Overview

7. Economic Overview Inflation: CPI increased by 2.2% in January 2007 Main factor pushing up the CPI has been the increasing cost of food (mainly higher grain prices) Chinese inflation reaches 11 year high due to soaring food prices (6.9% according to the latest IIF report)

8. Economic Overview

9. Capital Account �Liberalization leads to further development of a country's financial system which in turn is thought to enhance productivity in the real economy by facilitating transactions and by better allocation of resources.� (Mr. Stanley Fischer) Capital constraints still present in China Evidence shows that state owned enterprises have easier access to capital than their privately owned counterparties. FDI may be elevated because Chinese institutions protected foreign firms better than domestic ones.

10. Capital Account FDIs

11. Current Account Main Reasons behind the large surplus: The increasing trade balance at a high rate jumping from 58 billion dollar in 2004 to approximately 135 billion dollars in 2005 In the domain of services China is still importing more than exporting but still a significant level of improvement in many domains, especially financial, has decreased imports Private transfers have been increasing at an increasing rate due to the large number of Chinese working abroad Keep in mind the main drive of the surplus on CA is the trade balance!!

12. Current Account

13. Destinations of Exports & Origins of Imports

14. Trade Destination

15. Trade Surplus with Selected Partners

16. Trade Partners The US being the main destination of Chinese Exports the conflict of interest arises between two the world�s titans

17. POSSIBLE SCENARIOS Scenario A: Yuan remains pegged by Chinese government Scenario B: China decides to let the Yuan float with the market

18. SCENARIO A: Pegged Yuan Worsening of US current account deficit

19. SCENARIO A: Pegged Yuan

20. SCENARIO A In 2002-2003 the increasing level of exports had to be accompanied with an increase in imports China imported large amounts of intermediate materials, such as steel, to supply its investment boom Between 2004 and 2006 strong demand for more basic commodities, such as ores, and weaker demand for manufactured components and materials China�s imports shifted more towards natural resources Imports of petroleum products have increased rapidly from just 0.1% of total imports in 1985 to 9.5% in 2005 mainly due to rapid economic growth

21. SCENARIO A: Pegged Yuan China�s trade surplus is largely due to overall Chinese production efficiency Therefore, a Renminbi appreciation will not improve the world�s current account deficit

22. SCENARIO A: Pegged Yuan Greater undervaluation of RMB Increase on tariff and non-tariff restrictions from the US and EU Implementation of larger quotas and restrictions Deterioration of terms-of-trade Greater decline on price of Chinese exports Greater increase on price of Chinese imports Rise of uncontrollable inflation

23. SCENARIO A: Pegged Yuan Greater devaluation of other Asian currencies Increase on volatility for neighboring countries Increase on political tension Between China and the US Between China and the EU Increase on international sanctions Possible trade embargo against China?

24. SCENARIO A: Pegged Yuan Shift China�s international reserves Huge effect on US dollar, and thus US CAD

25. SCENARIO A: Pegged Yuan

26. SCENARIO A: Pegged Yuan Conclusion: �May God have mercy on us�

27. SCENARIO B: Floated Yuan Improvement of World�s competitiveness against Chinese exports Other Asian currencies will follow the RMB appreciation Asian currencies will also strength against the dollar Increase demand for their goods Asian economies will strength against international exposure It will increase consumption levels Rising Yuan will help stabilize Chinese overheated economy It will control rising inflation It will ease overinvesting

28. SCENARIO B: Floated Yuan Carbon Dioxide emission could reach alarming levels

29. SCENARIO B: Floated Yuan

30. SCENARIO B: Floated Yuan The impact on export prices will not be as much as the appreciation Ex.: 20% appreciation will only lead to a 4-6% increase on export prices (largely due to the price decrease on Chinese intermediary goods imports) It will not necessarily reduce US CAD due to substitution effect Chinese goods will be substitute with other Asian and LA goods (others will fill the gap) Chinese competitiveness will be affected Depending on the impact of Exports vs. Imports prices

31. SCENARIO B: Floated Yuan Only an appreciation of all Asian currencies will help decrease US CAD Ex.: 20% appreciation of all Asian currencies could decrease US CAD by $60-$80 billion USD Inflation largely due to increase in energy and food prices Yuan appreciation could lead to an increase in US inflation Increase in Chinese goods prices

32. SCENARIO B: Floated Yuan Wal-Mart: one of the biggest Chinese trade partners Trade partners might avoid inflation by diversifying suppliers (India for example) US companies might move out of China Outsource to other cheap labor countries Big US corporations see little impact on operation GE and Caterpillar: �we sell more in China than we buy from China�

33. SCENARIO B: Floated Yuan US current to need to inject liquidity into the market Yuan appreciation could lead to an increase in US interest rate levels Chinese appetite and necessity for US Treasury debt will decrease Ex.: in 2005, the 2.1% Yuan appreciation led to a decrease on the 10 year T-bond prices, and an increase on the YTM (from 4.18% to 4.29%)

34. SCENARIO B: Floated Yuan A hidden reason: A large number of Speculators are long the Yuan Warren Buffet is one of these speculators, given that the "Oracle of Omaha� is long this fact is considered by many a good indicator of the market Chinese officials claim that the volume of profit that might be generated by the appreciation might be enough motivation for the US to try to impose the appreciation

35. SCENARIO B: Floated Yuan Conclusion: A better off overall world economy �You cannot stay pegged forever�

36. Q&A ?

37. References Bloomberg CHOI, Hyun-ji. �Renminbi Undervaluation and the US-China Bilateral Trade Balance�. Boston College, May 2007. HUFBAUER, Gary, et al. �The US Congress and the Chinese Yuan�. Peterson Institute for International Economics, Conference on China�s Exchange Rate Policies. The Economist Intelligence Unit (EIU) The Financial Times The International Economy Publications, Inc. Yahoo! Finance