Harvard Business Case of International Finance , China to Float or Not to Float?

1853 Words Oct 17th, 2011 8 Pages
China: To Float or Not To Float?

International Finance

Executive Summary

On July 21, 2005, China revalued its decade-long quasi-fixed exchange rate of approximately 8.28 yuan per U.S. dollar by 2.1% to 8.11. Simultaneously, the People’s Bank of China announced that the daily trading band of 0.3% against the dollar would be maintained. Many analysts and economists believed that the real trade-weighted value of the renminbi was undervalued by up to 30% to 35%.

Companies that produce in China for the overseas market, retailers, and importers clearly benefit from an undervalued Chinese currency, as well as from the abuse of workers’ rights. On the other hand, companies actually producing in the foreign countries – whether for the
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US claimed imports from China caused great trade deficit and hurt American employment. Brazil said they also suffered trade deficit since China only imported basic products from Brazil while sold value-added products.

Q2. Linkage between China’s exchange rate policy and its development strategy

After the Asian crisis, growing capital flows into China and put pressure on the exchange rate. In order to keep the value of the yuan from rising against U.S. dollar in the face of these inflows, China’s central bank intervened by exchanging incoming dollars for renminbi at the fixed yuan exchange rate and using the dollars to buy dollar assets such as U.S. Treasuries. As FDI keeps flowing into China, the resulting excess reserves appeared to create an imbalance on China’s external balance sheet. In some economists’ view, the imbalance was necessary to support China’s development strategy, with reserves and current account surpluses serving as collateral for FDI inflows.

China’s priority is stability. Currency flexibility should not be allowed to conflict with this goal. Given that China is in transition, as an industrializing, and urbanizing economy with 300 million surplus workers, it faces immense challenges beyond the experience of many in the west. A sharp depreciation of renminbi will certainly reduce exports, increase unemployment, and force multinational companies with

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