Chinese Yuan Movement and Comparison with Indian Rupee


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Chinese Yuan Movement and Comparison with Indian Rupee

  1. 1. Factors of Movement of Exchange Rate between Chinese Yuan and US Dollar and comparison with Indian Scenario Department of Humanities and Social Science Under supervision of Dr. S. K. Mathur, Associate Professor of Economics, HSS Department IIT KanpurBy Ved Prakash 10790M. Sc. Integrated MathematicsIIT Kanpur
  2. 2. IntroductionChinese economy and currency have influenced international economy for a long time andChina has become the second largest economy in the world. The movements of ChineseRenminbi (RMB) have affected balance of payment of several major economies on largescale. The historical movement of RMB from an overvalued currency before 80’s toundervalue currency after 2005 have made a huge impact on Chinese balance of paymentand Chinese GDP. An overvalued currency allowed Chinese government to provide importedmachinery and equipment to priority industries at a relatively lower domestic currency costthan otherwise would have been possible. Cheap machinery mixed with high cheap laboravailability led to high production. A devaluation of currency after the reforms of 1979 ledto high exports and China continuously started having a current account surplus andaccumulated large stock of foreign reserves. In fact China currently has the highest reservesin the world of US Dollar.But this exchange rate is depended on several variables such as open interest parity, PPPTheory, Covered interest parity, money supply in domestic and foreign country, and incomein two country, difference between interest rates and difference of prices in the twocountries.Through this paper I intend to establish following task: 1. What factors have major significance in deciding the movement of Renminbi- Dollar exchange rate and why? 2. What is the equation that can be used to make prediction for coming years? 3. How the case of China is different from India? 4. What should China’s government do to ensure that country’s growth rate doesn’t go down?Various econometric models have been used in the paper and also explained as muchrequired. Ordinary least square, Generalized Square model and Variance Auto regressionhave been used in this paper.
  3. 3. Literature1. International Economics by Peter B. KenenThis book discusses the various factors that affect the Exchange rate for any country. Thereare several factors but the most important are:• Inflation Differential As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. For this paper I have used Inflation differential as Inflation Differential = Inflation China (in %) - Inflation US (in %) It can also be said that as inflation increases, commodities that you can buy with a givenamount of currency decreases and hence the value of your currency decreases. So withrising inflation, currency depreciates.• Interest Rate Differential Interest rate is one major instrument to attract foreign capital to move inside the home country. When interest rate in home country are more than interest rate in foreign country, then investors make more profit by depositing their money in the country with higher returns. So their exist open interest parity, u= r-r*, Where r= interest rate in home country and r* id interest rate in foreign country When interest rate is high there is more demand for home currency and hence the value of currency appreciates in home country and depreciates in the foreign country. In this paper I have used the data of Real interest rate = Lending Rate – Deposit Rate So higher the Real interest rate less is the money coming in. So the sign of coefficient will reverse in this case.• Money Supply The effect of money supply can be understood through monetary approach to balance of payment. When money supply increases, incentive to save is reduced thus people start demanding more goods which leads to increase in imports and thus the demand supply curve shifts causing home currency to depreciate with respect to the trading partner’s currency.
  4. 4. • Gross Domestic Product/ National Income More income gives the people a reason to spend more, thus when a country gains income, it starts getting more imports, which again leads to depreciation of importing country’s currency.2. The Future of China’s Exchange Rate Policy by Morris Goldstein and Nicholas R. Lardy This paper was very useful in gaining insight into the various exchange rate eras that China has passed through. It discusses evolution of China’s Exchange Rate Regime in the reform era, its transition to an equilibrium exchange rate and what development took place after 2005. China had a much overvalued currency from 1949 to 1970s, the state fixed China’s exchange rate at a highly overvalued level as part of the country’s import substitution industrialization strategy. In 1979, the State allowed exporters to retain a share of foreign exchange. Slowly these kinds of reforms increased in number and more and more foreign exchange was now controlled by Chinese exporters. The value of Renmimbi depreciated to 4.79 per $ in 1990 from 1.49 per $ in 1980. From mid 90s to 2005, China continuously maintained an exchange rate of 8.28 approx. After 2005, China started managing its currency “with reference to a basket of currencies” rather than pegged to the dollar. This change caused appreciation in value of Renminbi to 6.3 per $ as in 2012. Later in the paper, authors explain the surge in China’s Global Trade Surplus and in the end authors discuss the approaches that China can take in future. One is Stay- the- Course Strategy which says that China don’t need to do anything explicitly for exchange rates. China has done quite well with present structure and even if there were problems they were short lived and internal. China has maintained low inflation and dealt with all imbalances quite well. The other strategy is the Three- Stage Approach, the first stage being the time when economy is going through recession and second stage as the time when economy starts to recover. Third stage would be when China’s global current account surplus has been reduced. I take the future approach a little differently, through my result I say that exports of China will be going down in coming years because decreasing cheap labor and government of China will have to design policies such that the country’s growth will not go down in spite of changing global scenarios. I comment on the reasons behind difference in significant factors in deciding exchange rate in India/US and China/US. I derive my reasoning from the amount of trading taking place between these countries with other countries.
  5. 5. Econometric Model First task was to decide on the right hand side variables which explain the dependent variable and form a regression equation. π = f (Ls, L*s, Y,Y*, r-r*, p-p*) π = a + bLs + cL*s + dY*+ pY + q(r-r*) + r (p-p*) Expected Sign= +, -, -, +, +, + Where,• π = Exchange rate of Chinese Renminbi against Dollar,• Ls= Money Supply in China,• L*s= Money Supply in US,• Y= National Income or GDP of China,• Y*= National Income or GDP of US,• r = Real Interest rate of China ,• r*= Real Interest Rate of US,• p= Inflation in China,• p*= Inflation in US, The reason of these expected sign have been explained above and summarized here: When money supply increases in home country, people starts to save less and spend more which leads to increased imports and hence currency depreciates. For the foreign country, increased money supply will cause more exports for home country and thus appreciation of currency. Income behaves in the same way as money supply and thus for Home Income sign is +ve, and for foreign income sign is –ve. Interest rate changes are responsible for flow of money inside the home economy and outside of it. When real interest rate rises, deposit rate decreases, which leads to flow of currency outside home economy leading to depreciation of currency. So interest rate differential has positive sign. Similarly with rise in inflation differential, currency loses its value resulting in depreciation hence a positive sign.
  6. 6. Estimated Model The factors that are mentioned above are not the only variables that affect the exchange rate movements. There are several other factors; some of them are forward premium and other exchange rate with major trading partners. If the country is a managed float exchange rate economy, then it depends on the set of currencies that it has been pegged to. So the exact model should have been: π = a + bLs + cL*s + dY*+ pY + q(r-r*) + r (p-p*) +s (πf- πf*) +a1πPound-Yuan+ a2πEuro-Yuan + a3πYen-YuanHere,πf- πf* = Forward premium difference,πPound-Yuan = Exchange rate between Great Britain Pound and Chinese Yuan,πEuro-Yuan = Exchange rate between Great Britain Pound and Chinese Yuan,πYen-Yuan = Exchange rate between Great Britain Pound and Chinese Yuan,The reason that these extra variables were not included is that for the case of China,including other exchange rate was disturbing all other results. Secondly, the data forforward premium was not available for both the countries.Also, the limited number of variables was able to explain the majority of variability in theresults, so the significance of including other variables reduced considerably.Data SourceMost of the data has been downloaded from World Bank, World Development IndicatorsProcedure to access data,Step 1- Go to 2- Select the database as World Development IndicatorsStep 3 – Select China and United State as countryStep 4- Select the variables for which the data is requiredStep 5- Download the data in excel sheet.This source is the most reliable source of economic data and the data is available across alldatabases and for almost all countries.
  7. 7. Results EViews 3.1 and STATA 8 were used for carrying out several tests. The result of each of those test are described below: Data GDP Inflation Interest MS China(Mil GDP US ExchangeYear Differential Rate Diff. China $ MS US $ $) (Mil $) Rate1980 -5.32717 -4.43059 1.67E+11 1.99E+12 306520 2768900 1.49841981 -7.07981 -5.99789 1.98E+11 2.23E+12 293852 3105400 1.7045331982 -6.34266 -0.79597 2.27E+11 2.45E+12 295370 3229500 1.8925421983 -2.95531 -0.44004 2.71E+11 2.65E+12 314637 3508800 1.9756751984 1.180511 -5.82954 3.6E+11 2.98E+12 317352 3902600 2.3200421985 7.150013 -8.748 4.87E+11 3.23E+12 309083 4187500 2.9366581986 2.51245 -2.93539 6.35E+11 3.53E+12 304348 4427700 3.4527921987 2.228091 -2.49679 7.96E+11 3.68E+12 329851 4702100 3.72211988 8.59983 -8.3863 9.6E+11 3.93E+12 413439 5063900 3.72211989 4.746342 -4.24368 1.14E+12 4.14E+12 459782 5441700 3.7651081990 2.045907 -2.66218 1.47E+12 4.25E+12 404494 5757200 4.7832081991 3.451021 -3.22267 1.86E+12 4.31E+12 424117 5946900 5.3233921992 6.13114 -3.68793 2.43E+12 4.3E+12 499859 6286800 5.5145921993 12.92879 -7.32316 3.57E+12 4.33E+12 641069 6604300 5.7619581994 18.57137 -12.9829 4.69E+12 4.35E+12 582653 7017500 8.6186671995 11.4098 -7.82868 6.07E+12 4.65E+12 756960 7342300 8.351251996 4.664643 -2.96274 7.61E+12 5.01E+12 892014 7762300 8.3140831997 -0.41487 0.63018 9.19E+12 5.41E+12 985046 8250900 8.2898331998 -2.26338 0.458259 1.06E+13 5.93E+12 1045199 8694600 8.2791999 -2.72108 0.761529 1.21E+13 6.5E+12 1100776 9216200 8.2780832000 -0.1015 -3.20864 1.36E+13 7.02E+12 1192836 9764800 8.2784172001 -0.21421 -0.83065 1.56E+13 7.55E+12 1316558 10075900 8.2771672002 -1.03969 1.695993 1.77E+13 7.88E+12 1454040 10417600 8.2772003 0.505075 0.655339 2.11E+13 8.23E+12 1647918 10908000 8.2772004 4.10138 -2.7334 2.42E+13 8.7E+12 1936502 11657300 8.2768332005 0.610488 -1.18985 2.83E+13 9.41E+12 2302719 12397900 8.1940832006 0.559569 -2.33435 3.46E+13 1.03E+13 2787254 13163870 7.9733332007 4.70286 -5.12841 4.03E+13 1.15E+13 3494351 14028700 7.6075832008 5.586504 -5.12181 4.75E+13 1.24E+13 4531831 14369100 6.948752009 -1.6568 3.775042 6.1E+13 1.23E+13 5050543 13863600 6.8314172010 5.531783 -2.89312 7.26E+13 1.21E+13 5739358 14447100 6.7701672011 5.022673 -1.61297 8.52E+13 1.3E+13 7318449 15075000 6.4615
  8. 8. Ordinary Least Square Test Fig 1 Results of OLS • It can be noticed that the value of Durbin –Watson Stat is 1.47 which indicates the presence of correlation among the variables. • The value of R- Squared is 0.94 which shows that these variables are quite nicely explaining the variability of exchange rate. • Differential Inflation, Differential Interest rate, GDP US and money supply US are significant factors explaining exchange rate value. (Probability value is less than 5% for each of them and also absolute value of t-stat is greater than 1.96 for each of them) These results are interesting. It is important to know that why money supply and GDP of China are not as important as MS and GDP of US.• China is an export based industry. Much of its income comes from export of manufactured goods. Complete report of its trade statistics can be obtained at US are major trade partner of China with a trade volume of 500 billion Dollars. So the money supply and GDP changes in US affect China’s export to US a lot more than its own GDP and money supply’s effect on its imports.• The reason behind interest rate being significant factor is that China has continuously invested in US treasury bills, so whenever the differential interest rate support the purchase of US treasury bills, China purchases those bill increasing money supply and expenditure in US and thus ultimately increasing China’s export to US. The exact volume of US treasury bills held by China can be obtained at center/data-chart-center/tic/Documents/mfh.txt.
  9. 9. • When Differential index is low, it means that inflation is low in China and high in US. Because of this reason US people prefer more of China’s cheap and inexpensive products. Thus US’s imports from China increases and low inflation appreciates Chinese currency. But as the value of Durbin- Watson Stat is indicating the presence of correlation, remedial measure is required to correct the results. We run generalized least square test on the same data. The results are presented below, Generalized Least Square Fig 2 Results of GLS• After applying the remedial measure, i.e. by using the GLS test on the data, the value of Durbin-Watson constant has reached closer to 2, so much of the correlation error has been reduced now.• Also, the value of t-stat for Differential inflation and differential interest rate reduced to 1.83 and 1.84 which are less than 1.96, and these factors also lose significance.• Although both differential inflation and differential interest rate still have probabilities under10 % and Money supply and GDP of US remains the significant factors.• The most important thing to note is that the data that is being used here is a time series data, so auto correlation is not the only thing that I required to be checked.• The Unit Root test is needed to be checked to find out, whether the data series are stationary or not.
  10. 10. Unit Root TestOn running Unit test root on all the series, the following results were obtained: • All series had unit root problem and were non stationary. With this finding, it is sure that the results obtained from linear regression are wrong since OLS and GLS results are valid only for stationary series. • The options that are left now are that either co-integration test can be run on the data or Vector Auto Regression test. • If all series turn out to be of same order (I0 or I1 or I2), then co-integration test can be applied because the series are integrated to same level.
  11. 11. Fig 3 Results of Unit Root Test1. Inflation differential series was integrated to I1 level.2. Differential Interest Rate series was integrated to I2 level.3. Money Supply China series was integrated to I3 level.4. Money Supply US was series integrated to I1 level.5. GDP China series was integrated to I0 level and,6. GDP US was integrated to I1 level. Since the integration level of all series is not same, so the use of co-integration test would not give correct results. The only choice remains to run Vector Auto Regression test. Vector Auto Regression VAR is a very important model in econometrics; it’s a concise way of summarizing data; the residuals generated by VAR have very little correlation; can be used to examine complex relation among many variables. A simple vector auto regression for two variables y and z is Yt = αy +βyyt-1 + γy zt-1 + εyt Zt = αz + βzyt-1 + γzzt-1 + εtz Where, The α’s and β’s are parameters, The epsilons are white noise, i.e. Eεit =0, Var εit = σ2 and Cov(εit, εjt) =0
  12. 12. This model can be generalized for more variables. EViews comes with an inbuilt algorithm toexecute VAR estimation, that is what has been used here, Fig 4 VAR estimate Results for Dependent VariableVariance Decomposition Result Impulse Response in 10 time period GDP US Exchange 5% Rate 5% Inflation GDP 44% China 23% M S US Interest 10% M S Rate China 5% 8% Fig 5 Impulse Response Results with normal ordering
  13. 13. In impulse response, the ordering of the variables matter because the amount of variabilityexplaining ability of variable goes down as its sequence number decreases. So it’s importantto check results with different ordering.With this particular ordering, the results show that inflation will be major influential factorin determining the exchange rate in 10 time period and GDP China and MS China will alsobecome important factor in future.Results with different ordering1. MS US, GDP US, MS China, Diff. Inflation, GDP China, Diff. Interest Rate, Exchange Rate2. MS China, GDP China, MS US, GDP US, Diff. Inflation, Diff. Interest Rate, Exchange Rate Fig 6 Ordering 1 Result GDP US 5% Exchang e Rate 5% With this ordering, Inflation (38%) still remains a major factor but along Inflation with it, GDP (22%) and Money GDP 38% Supply (19%) in China also become China important factor with the 22% significance of GDP (5%) and Money M S US supply (10%) going down in next 10 10% MS time periods. China Interest 19% Rate 1% GDP US 5% Exchang According to this ordering, GDP of e Rate China (54%) will take place of 5% Inflation Differential inflation as most 5% significant factor, MS in China will GDP Interest explain 19 % variability in next 10 China Rate time period. The significance of GDP 54% MS 1% China and MS is reduced to low levels and 19% interest rate and inflation become M S US almost irrelevant. 11% Fig 7 Ordering 2 results
  14. 14. These results with different ordering have something in common, i.e. • The significance of money supply and GDP will go up in future and China’s exchange rate dependence on US economy will go down. • This can be interpreted as fall in China’s exports to US and China’s overall trade going down. • China’s exchange rate will depend more on internal demand and supply of foreign exchange. • A possible reason of this may be that, in coming year China will lose it comparative advantage over products from other countries because of diminishing availability of cheap labor. [] • Population of China is getting old (average age is increasing), so the wage rates are going high in China and that’s why the Chinese product will not be cheap as before, so a net decline in exports will cause more home based changes than US based changes. To get the final equation and to do forecasting, we need the value of normalized beta coefficients, which can be obtained in STATA. The results from STATA are given below, Fig 8 Normalized Beta Coefficients Var2= Differential Inflation, Var3= Differential Interest Rate, Var4= Money Supply in China, Var5= Money Supply in US, Var6= GDP China, Var7= GDP US I will consider only those variable for which absolute value of t-stat is greater than 1.96 and the probability value is less than 5%. These variables are: 1. Differential Inflation 2. Differential Interest Rate 3. Money Supply in US 4. GDP US
  15. 15. Final Equation: π = a + bLs + cL*s + dY*+ pY + q(r-r*) + r (p-p*)π = .1706 + 0*Ls – (2.16E-12)L*s + (2.42E-06)Y*+ o*Y + .1376(r-r*) + .0923 (p-p*) π = .1706– (2.16E-12)L*s + (2.42E-06)Y* + .1376(r-r*) + .0923 (p-p*) In- Sample Forecasting Fig 8 Table for Forecasted values of Exchange Rate (In Sample) Year Actual Exchange Rate Forecasted Values Difference 1980 1.4984 1.479765 0.018635 1981 1.704533 1.398976 0.305557 1982 1.892542 2.001109 -0.10857 1983 1.975675 2.601297 -0.62562 1984 2.320042 2.476583 -0.15654 1985 2.936658 2.781104 0.155555 1986 3.452792 3.079855 0.372936 1987 3.7221 3.467739 0.254361 1988 3.7221 3.58156 0.14054 1989 3.765108 4.259095 -0.49399 1990 4.783208 4.751651 0.031557 1991 5.323392 5.125678 0.197714 1992 5.514592 6.145956 -0.63136 1993 5.761958 6.986216 -1.22426 1994 8.618667 7.690343 0.928324 1995 8.35125 7.879416 0.471834 1996 8.314083 8.153351 0.160732 1997 8.289833 8.494864 -0.20503 1998 8.279 8.251661 0.027339 1999 8.278083 8.294993 -0.01691 2000 8.278417 8.179949 0.098467 2001 8.277167 8.117598 0.159569 2002 8.277 8.499348 -0.22235 2003 8.277 8.925396 -0.6484 2004 8.276833 9.587266 -1.31043 2005 8.194083 9.73684 -1.54276 2006 7.973333 9.593501 -1.62017 2007 7.607583 9.081372 -1.47379 2008 6.94875 7.959028 -1.01028 2009 6.831417 7.483228 -0.65181 2010 6.770167 9.177648 -2.40748 2011 6.4615 8.840639 -2.37914
  16. 16. It can be seen that the forecasting is right for most of the years, it is only after year 2005,that the forecasting is giving wrong results. One of the reasons of it can be that after year2005, China changed its exchange rate regime, it pegged its currency to a basket ofcurrencies, and thus the value of Chinese Yuan was dependent on other exchange ratesalso.Based on this model the out of sample forecasting is done the following way,For next five years, GDP growth rate has been used to determine future GDP. The trend ofMoney supply increase has been used to get future money supply values and the mean oflast five years of differential inflation and differential interest rate is being used forobtaining the values of future inflation and interest rate differentials. Fig 9 Forecasted Values using same model (Out Of Sample) Year Diff. Diff Interest Money GDP US Forecasted Rate Inflation Rate Supply US 2012 3.837405 -2.19625 1.4E+13 15373485 7.233181 2013 3.837405 -2.19625 1.5E+13 15677880 5.795345 2014 3.837405 -2.19625 1.6E+13 15988302 4.33775Differential Inflation = average value of inflation differential for year 2007, 08, 09, 10, 11Differential Interest Rate = average value of interest rate differential for year 2007, 08, 09,10, 11Money supply Excess= (1.59E+10)*Year value – (3.1E+13) Obtained through linearregression on money supply increase every yearGDP US: A forecast of GDP growth rate of 1.98 as provided by World Bank is used to get thefuture value of GDP Variation in the current regression modelAs the result for forecasted value were not appropriate after the year 2005, so I tried amodification in regression model and included Exchange Rate of Yuan –Yen and Yuan –Pound as my explanatory variables. After running the similar results on these variables, Ifound that only Yuan –Yen exchange rate and Yuan – Pound Exchange rates are significantvariables, so using the beta coefficients I formed the following equation: Π= .9461+ .2194*πPound-Yuan+ 44.2215*πYen-Yuan
  17. 17. Based on this modified model, I again forecasted the value of Exchange rate for last 7 years,the result of which is given below: Fig 10 Forecasted values with improvised model Year Actual Exchange Rate Forecasted Rate 2005 8.194083 7.504279 2006 7.973333 7.201861 2007 7.607583 7.14476 2008 6.94875 6.741718 2009 6.831417 6.522745 2010 6.770167 6.656823 2011 6.4615 6.804896These results can be explained by the facts that Chinese government on 21 July, 2005announced that the Chinese Currency is a managed float and is now pegged to a basket ofcurrencies among which Pound and Yen are two important ones.[] That’s the reason this forecast are muchcloser to actual values. Comparison with IndiaWhile comparing with India, the number of variables included on right hand side were morethan in case of China, the extra addition were Pound Rupee Exchange Rate, Euro/RupeeExchange Rate and Japanese Yen/Rupee Exchange Rate.The results of normalized beta coefficients for Indian data are given below: Fig 11 Results for beta coefficients and regression for Indian Data
  18. 18. The differences between Chinese model and Indian model can be sketched in following manner: India China• All the three exchange rates, i.e. • Chinese Yuan also was significantly affected by pound/rupee, euro/rupee and Yen/rupee these rates since China manages its exchange come out to be significant. The reason for rate based on the value of these currencies. this India has a lot of trade with these Japan is China second major trade partner and three regions on Indian map and also UK is also one of the important trade partner. because the basket of currencies to which [ India has pegged its exchange rate tm] contains these exchange rates. [Export- Import bank of India, Catalyzing Indias trade and investment]• For India, not only GDP of US is significant • In case of China, China’s own GDP and money variable, but also its own GDP and money supply were insignificant instead US GDP and supply. Money supply were important factors.• By applying VAR and impulse response on • By applying variance decomposition and impulse Indian data, it can be said that Pound response, it can be said that Chinese GDP and Rupee exchange rate, Yen Rupee Chinese Money Supply will become significant in Exchange Rate and Interest rate coming years differential will gain even more significance.• By this result it can be said that India • The average age of Chinese population is trade with these countries will further increasing. In next 10-15 years the number of increase in future. Inflation, GDP and people above retirement age will be 65million. Economic changes in these regions will be This indicates to a lack of cheap labor in future reflected in the way India’s currency which will cause rise in prices of manufactured value changes. goods from China. This will lead to decreased exports and thus Chinese currency value will depend more on its own internal GDP and Money supply condition. This theory is well explained in my own research work available at [ Paper-SOC-479]
  19. 19. Conclusion and DiscussionAfter this study, we are in the situation to answer the questions asked in the beginning ofthis paper which were: 1. What factors have major significance in deciding the movement of Renminbi- Dollar exchange rate and why? 2. What is the equation that can be used to make prediction for coming years? 3. How the case of China is different from India? 4. What should China’s government do to ensure that country’s growth rate doesn’t go down? The factors that have most significance and effect on Chinese currency value are differential inflation in China, differential interest rate in China, Money supply and National Income of US. Inflation rise in China causes fall of exports and hence demand of Yuan goes down leading to depreciation of Yuan, that’s why a positive sign is seen in the results. Rise in differential inflation causes more purchases of US treasury bills by China’s central bank, leading to excessive supply of Yuan and thus depreciation. This explains the reason of positive sign. With increasing GDP levels, US engages even more in international trade causing dollar to lose value against major currencies such as euro, yen and pound. Since China has pegged its currency to dollar for a long time, so any such depreciation causes Yuan to depreciate against US Dollar. That’s why a positive sign for US GDP. When China buys more of US treasury bills, it increase money supply in US and hence US takes more imports from China, leading to appreciation of Yuan and hence a negative sign for money supply in US. The equation obtained is π = .1706– (2.16E-12)L*s + (2.42E-06)Y* + .1376(r-r*) + .0923 (p-p*),This equation gives correct forecasting till year 2005, but then because change in exchangerate regime in China, a new improvised model was implemented where Yuan exchange rateversus British Pound and Japanese Yen were found to be significant factors. And the newequation was Π= .9461+ .2194*πPound-Yuan+ 44.2215*πYen-YuanThis equation gave far better results of forecasting (in sample) after 2005, then the previousequation.
  20. 20. China’s case is different from India in the way that China’s economy is based around exportsof good to outside countries mainly to US and Japan while India’s economy is more drivenby both direction trade and direct investments. Also, India trade with US is much lesscompared to China’s trade so India is not so much affected by economic changes of UnitedStates.China’s future growth depends on the value of Yuan and the competitive advantage ofChinese goods. China faces pressure from all over the world to appreciate its currency butthat will lead to reduced exports which China would not like at all. To let the Yuan freelyfloat, China should allow all its residents to hold foreign currency and buy foreign assets.This would allow the Chinese Government to hold fewer dollars and lessen the tradeimbalance with the U.S. Then there would be less focus by the U.S. Congress calling for anincrease in the Yuans value [The Future of China’s Exchange Rate Policy by Morris Goldsteinand Nicholas R. Lardy].China should start to invest in its service sector and information technology sector like India,so that even in case of reducing exports of manufactured good, the total exports don’t godown and hence China would be able to maintain its export oriented growth.Most of the results match with what other studies have shown and almost every result arejustified by theory behind it. The literature completely supports the predictions made bythis study.Ending NoteThis study can be extended further; many more variables should be included in theregression if data is available for them. The result will improve significantly if someone canget data for Chinese economy even before 1980 and regress it on US data.The dependence of Yuan on Euro should also be considered and further studies can be doneto calculate what weightage each currency has got in its currency basket.
  21. 21. References1. International Economics by Peter B. Kenen2. The Future of China’s Exchange Rate Policy by Morris Goldstein and Nicholas R. Lardy3. World Bank, Databank Statistics of China’s International Trade Details of countries holding US treasury bills Ageing China: Challenges and Solution Renminbi Rate Regime Information Export-Import bank of India, Catalyzing Indias trade and investment9. Impact of Changing Chinese Demography on Economic Growth