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

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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…show more content…
Impact of growth in China as well as the rest of the world by the changes in exchange rate policy As most observers took it for granted that the yuan was undervalued, one specific study estimated yuan undervaluation against the U.S. dollar of at least 35% based on the price level of goods and services in China compared with those of its trade partners. As a result, there will probably be a sharp appreciation of renminbi if Chinese government switches over from the fixed exchange rate policy to flexible exchange rate policy. A common figure cited for a 20 to 25 percent move of renminbi would be devastating to China, which would cause deflation, cut economic growth, cut off foreign direct investment and would destabilize Asia. On the other hand, other low-cost countries in Asia may benefit from the shift of FDI and production of multinational companies. However, most high-wage countries like U.S. may still face a rising trade deficit because their imports from other low-wage countries would replace products made in China. Sustainability of the current exchange rate policy Many economists – focusing on the strain the tightly managed exchange rate imposed on China’s economy – agreed that China needed to institute more flexibility. They noted that not only was the exchange rate expensive to sustain, but it contributed – as well as limited China’s flexibility in responding – to a

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