The external impact of China’s renminbi policy – not so simple

It’s always nice to see a bit of academic clarity injected into a muddy debate. And in a paper published on Wednesday looking at the impact of renminbi appreciation on company valuations, Barry Eichengreen and Hui Tong (of Berkeley and the IMF) do just that.

The authors’ findings suggest that, unfortunately for those who advocate a “RMB must appreciate now” position, the actual situation is not that simple: it is entirely conceivable that a RMB appreciation might have overall negative consequences for foreign firms.

Using movements in share price of 6,000 manufacturing firms in 44 economies, Eichengreen and Hui examined the market’s response to two announcements of changes in China’s currency policy in 2005 and 2010 which plausibly created expectations of faster renminbi appreciation.

The authors also considered four instances of market-perceived changes in exchange rate policy, as reflected in unusually large reniminbi movements on the futures (non-deliverable forwards) market, each of which was associated with political (as opposed to economic) factors.

The authors found that:

Expectations of RMB appreciation appears to impact the valuations of firms outside of China both through a general market-sentiment effect, which plausibly reflects diminished fears of trade sanctions and retaliation, and a set of trade-related channels.

Eichengreen and Hui argue that while firms exporting goods to China do benefit from RMB appreciation as Chinese buying power rises, firms selling inputs to China for use in manufacturing were most likely to suffer.

There is also some evidence that RMB appreciation would benefit firms competing with China in home and other markets, but the effect in their home market is weaker for firms in sectors where China’s exports have large imported input content. In effect, companies are importing back China’s increased costs.

Finally, the authors found evidence of a negative impact on debt-dependent firms which find it more costly to fund their operations as a result of the upward pressure on yields resulting from reduced Chinese purchases of foreign treasury bonds – which China currently buys in large quantities to prevent the RMB from rising against the dollar.

In other words: either China buys your government debt to keep the RMB down, or you pay more in borrowing costs. The higher the yield for government debt, the higher the yield for corporate paper in that country.

Eichengreen and Hui sign off with a suitably undramatic summary:

Overall, the message is that across-the-board inferences are misleading. The impact of renminbi appreciation, actual and prospective, on firms, sectors and countries will be very different depending on their circumstances and the specific nature of their interaction with China.

Somebody please let the US Senate know. If they can follow the argument.

Related reading:
Renminbi: not so fast, beyondbrics
Traders prepare for falling renminbi, beyondbrics
Renminbi: ‘Redback’ puts the brakes on, FT