PRESENTED BY : GROUP 3PARMITA SHRESTHASAJANI MALLASUBASH SILWALSUJATA MANANDHAR

Case Analysis of China Pegged Exchange Rate

Ace Institute of Management, Sinamangal, Kathmandu,Nepal 04/08/23

1

Summary Of Case

Since 1994 China has pegged the value of its currency the yuan to the US dollar at an exchange rate of US $1 to 8.28 yuan.

To preserve the value of yuan against the dollar the Chinese central bank regularly bought or sold dollar and has stricter currency control than most countries.

Early 2005 pressure was building for china to alter its exchange rate policy .

Pegged exchange rate undervalues the yuan by as much as 40 percent .

This has resulted the boom in China export and limit imports.

It has lead to job losses of American manufacturing

Ace Institute of Management, Sinamangal, Kathmandu,Nepal 04/08/23

2

Summary Of Case

Pegged exchange rate system has been problematic to Chinese too.

Reported that in 2004 the annual inflation rate rose above 5% for the first time in seven years.

Question was raised whether china shall moved to floating exchange rate regime.

Circumstances - Chinese banking system is very weak. As much as 50% of all bank loans are nonperforming.

Moving quickly to free float raises the possibility of destabilizing the economy even more.

Chinese are taking step to restructure their banking system, increasing the loan loss reserves of banks and removing political influence from lending policies.

They are also actively debating a gradual approach toward changing dollar/yuan exchange rate.

Ace Institute of Management, Sinamangal, Kathmandu,Nepal 04/08/23

3

Summary Of Case

Thus, this is the case about :• Benefit and cost to china due to its pegged

exchange rate. • Factor china need to consider before moving to

floating exchange rate regime .• Gives us idea about impact to foreign firms which

have invested in china due to yuan floating exchange rate regime and appreciate in value .

• Information about shall yuan float, maintain the peg or change the peg in some way.

Ace Institute of Management, Sinamangal, Kathmandu,Nepal 04/08/23

4

Reasons for pegging the value of the Yuan against the U.S. dollar

To fuel a boom in Chinese exports to the West particularly to the United States.

To manage its foreign exchange rate risk as most of the Chinese exports are made from dollar-denominated imported materials and energy.

To mitigate the risk for investors coming into China.

04/08/23

5

BenefitsBenefits CostsCosts

Able to stabilize its economy

Prevent U.S. Dollar from devaluation as Chinese leaders are currently holding about 9 hundred billions in American Treasury bills and bonds

Manage the peg due to which it has to be active in the foreign exchange markets

Dollar’s movement up or down affects the Chinese economy

Benefits and Cost for china by pegging Yuan with U.S. Dollar

04/08/23

6

Over the last decade, many foreign firms have invested in china and used their Chinese factories to produce goods for export. If the Yuan is allowed to float freely against the US dollar on the foreign exchange markets and appreciates in value, how

might this affect the fortunes of those enterprises?

04/08/23

7

Affect on enterprises operating in China

Pros:Positive reaction from financial markets as investors

registered their belief that change would give Chinese consumers greater spending power

Equipment manufacturers and consumer products makers operating in China could benefit

For instance; the Yuan’s rise could help foreign carmakers operating in China — including GM and Ford — by making imported auto parts less expensive.

Cont….

Cons:Production costs will rise in China as a result it will

affect multinationals companies which rely on china's low-cost labor

Pressure to move their manufacturing to lower-cost countries such as India and Vietnam

Cont…….

The consumers of Chinese product will have to suffer as the cost will be transferred to them in the form of high prices.

For instance, some retailers that supply from China — like the European clothing stores H&M Hennes & Mauritz and Next Retail — could see their expenses rise as a result of the decision.

04/08/23

10

Should the US government push the Chinese to let the Yuan float freely?

Choice of any nation to decide on which exchange rate regime it should follow either floating or pegged

China engaged in heavy foreign exchange market intervention in order to keep its currency pegged to the U.S. dollar

It turned out to under value the Yuan helping to fuel a boom in Chinese exports to the West particularly U.S.

04/08/23

11

The cheap Yuan harming:American manufacturesLeading to job losses Threatening the case of free tradeThus, the U.S. government should push the

Chinese to let the Yuan float freely.The effect of a Yuan appreciation would

deliver an extra return for U.S. investors in Chinese assets.

It is beneficial to protect its nation from future economic crisis.

04/08/23

12

What should the Chinese government do?

China should not let its currency freely floatThe pegged Yuan to the Dollar is increasingly

creating problem for Chinese too.Floating exchange rates tend to be highly

volatile and destabilizing in countries with underdeveloped domestic financial markets as the local companies would be exposed to exchange rate risk and the already financially troubled state-owned enterprise sector might collapse.

04/08/23

13

It will jeopardize their export-led strategyA large appreciation would translate into a

large drop in Chinese import prices; agricultural imports would threaten millions of Chinese farmers

A lot of overseas investors might move their factories or companies out of China

04/08/23

14

In Conclusion

China should be accompanied by deep reforms in different areas such as:

Banking should be recapitalized and restructured

Bad loans should be provisioned fully State owned companies' should be monitored

and managed well to lessen the burden of debt.Removing political influence on lending policies.Thus, China should change its peg some other

way so that it will not put the global economic recovery at risk.

04/08/23

15

Thank You!!

04/08/23

16