China’s Current Account and Exchange Rate

1. China’s Current Account and Exchange Rate Yin-Wong CHEUNG, UCSC & HKU Menzie D. CHINN, UW-Madison & NBER Eiji FUJII, University of Tsukuba NBER Conference “China’s Growing Role in World Trade” August 3, 2007

2. China’s Current Account Source: IMF, World Economic Outlook April 2007 database

3. The Value of CNY Source: IMF, International Financial Statistics, author’s calculations

4. Trade Balance and Forex Reserves Source: IMF, International Financial Statistics

5. Outline • An analysis of the CNY misalignment issue using the standard deviations-from-Absolute PPP approach • Highlighting the tension between economic and statistical significance • Closer look at elasticities from a macro perspective • The importance of uncertainty arises again • Exchange rate is important but not central

6. Evaluating the Exchange Rate

7. Data from World Development Indicators, 1971-2005 Vintages of WDI matter (the China path is substantially different than our previous paper) The r is in PPP terms, the y in USD, PPP terms Exploiting the “Penn Effect”

8. The “Penn Effect” Estimated

9. The “Penn Effect” Illustrated (I)

10. The “Penn Effect” Illustrated (II)

11. Observations • The 2005 CNY is about 1.5 standard errors from conditional mean, so statistically not misaligned • But the point estimate indicates a 50% (!) undervaluation (in log terms) • If one changes the definition of undervaluation as (e.g.) 3 consecutive years of misalignment, not much changes since ρ ≈ 0.95

12. Investigating China’s Trade Elasticities

13. Multilateral Trade Elasticities • Standard static imperfect substitutes approach. • Analysis conducted on quarterly frequency, over 1993-06 period. • Sample period largely dictated by data availability (changes in data collection). • y, y* are real GDP, q is CPI deflated, z is supply variable, w additional demand factor

14. Chinese Exports

15. Two (Recurring) Problems • Chinese export data don’t match rest-of-world import data, vice versa • No Chinese deflators, pre-2005 • We rely on the Chinese data for multilateral exports, imports • We try various proxies as deflators

16. Proxies for Export Deflators

19. Observations • Holding z constant results in really high income elasticity estimates, wrong sign on exchange rate. • For aggregate exports, only z matters. • For ordinary exports, income is insignificant, while others come in significantly • Processing and parts exports fit quite well • All results sensitive to inclusion of trend

20. Chinese Imports

21. Proxies for Import Deflators

23. Some Observations • Aggregate, ordinary imports have wrong signed price elasticities • Processing and parts imports only slightly better behaved

24. Alternative Import Specification • Since others have suggested a link between parts imports and exports, we include total exports, w • This yields more intuitive estimates for the exchange rate elasticity

25. Implications for Policy (I) Multilateral basis, 10% appreciation leads to • A decline of imports by 70 bn • A rise in the TB of 15 bn • Zeroing out the perverse elasticity leads to a decline in the TB of 46 bn • 2006 TB was 956 bn (2000$) • ( < $86 bn in Marquez-Schindler) • A decline of exports by 25 bn (2000$)

26. Bilateral Trade Elasticities • The standard equation augmented with a trade weighted ex-U.S. real exchange rate variable • The q is now CNY/USD (CPI deflated) • We examine both Chinese and US measures of China-US trade

27. Chinese Exports to U.S.

28. What Accounts for the Differences? • For Chinese exports, Chinese record as f.o.b., US reports as c.i.f. • Chinese goods transiting HK might or might not be correctly attributed to China • Value added in HK might be improperly attributed to China (see e.g., Schindler and Beckett, 2006)

29. Proxies for Chinese-U.S. Export Deflators

30. CNY/USD Real Exchange Rate Note: “Adjusted” indicates nominal exchange rate takes into account transactions taking place at floating rate.

31. Chinese Bilateral Export Elasticities

32. Chinese Imports from U.S.

33. Proxies for Chinese-U.S. Import Deflators

34. Chinese Bilateral Import Elasticities

35. Implications for Policy (II) A 10% real appreciation of CNY/USD results in • 33 bn (2000$) reduction in trade balance • The 2006 China-US trade balance was 229 bn (2000) • No necessary implication for overall US trade deficit

36. Next Tasks • Formal calculation of misalignment probabilities • Checking for sensitivity to additional regressors • Alternative measures of rest-of-world GDP (export weighted GDP, world imports)