Should Rmb Appreciate

Recommendation for appreciating the RMB

China’s economy has been growing at above 10% in the past four consecutive years: 10% in 2003, 10.1% in 2004, 10.4% in 2005, and 10.7% in 2006. The strong growth is primarily driven by foreign trade, fixed asset investment, and to some extent domestic consumption. The large trade surplus pushes China to buy more foreign currency. China’s foreign exchange reserves have become more than that of the United States, which was the biggest in the world with reserves of 1

Trillion. This would result in the depreciation of foreign currencies and the anticipation of RMB appreciation. Which in-turn stimulates speculation for profit on RMB appreciation. (ref)

The pressure for RMB to appreciate mainly comes from the devaluation of USD. The USD had decreased by 4% against the Euro at the end November 2006 due to the slow-down of the United States housing industry and weakening the consumer’s confidence. The RMB appreciation can mainly be attributed to China’s fast economic development, excessive trade surplus, devaluation of the USD and capital inflow caused by an anticipation of RMB appreciation for profit-taking.

Currency appreciation means an increase in the value of one currency with respect to another. This means that one unit of the appreciating currency buys more units of the other currency than it did previously. By understanding what currency appreciation is, helps identify the effects of appreciating or not appreciating the RMB currency.

The general economic effects of a currency appreciating are as follows:

* Exports become more expensive, therefore less Chinese exports will be demanded.

* Imports become cheaper, therefore more imports will be bought.

* Lower inflation because import prices are cheaper and more incentives to cut costs.

  Effects of the RMB on China’s Economy

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