China’s Current Account and Exchange Rate

Yin-Wong CHEUNG, UCSC & HKU

Menzie D. CHINN, UW-Madison & NBER

Eiji FUJII, University of Tsukuba

NBER Conference

“China’s Growing Role in World Trade”

August 3, 2007

China’s Current Account

Source: IMF, World Economic Outlook April 2007 database

-40

0

40

80

120

160

200

240

280

320

-.04

-.02

.00

.02

.04

.06

.08

.10

.12

.14

1980 1985 1990 1995 2000 2005

Current Account(bn USD)[left scale]

Current Accountto GDP ratio[right scale]

The Value of CNY

Source: IMF, International Financial Statistics, author’s calculations

-5.2

-5.0

-4.8

-4.6

-4.4

-4.2

-4.0

86 88 90 92 94 96 98 00 02 04 06

Real TradeWeighted CNYExchange Rate

Feb.'075.5%

Thai bahtdevaluation

Chinese yuanrevaluation

Trend

Trade Balance and Forex Reserves

Source: IMF, International Financial Statistics

-10

-5

0

5

10

15

20

25

0

200

400

600

800

1,000

1,200

1,400

90 92 94 96 98 00 02 04 06

Chinese Trade Balance(nsa, bn. USD)[left scale]

Forex Reserves(ex-gold, bn. USD)[right scale]

Outline

• An analysis of the CNY misalignment issue using the standard deviations-from-Absolute PPP approach

• Highlighting the tension between economic and statistical significance

• Closer look at elasticities from a macro perspective

• The importance of uncertainty arises again

• Exchange rate is important but not central

Evaluating the Exchange Rate

Exploiting the “Penn Effect”

• Data from World Development Indicators, 1971-2005

• Vintages of WDI matter (the China path is substantially different than our previous paper)

• The r is in PPP terms, the y in USD, PPP terms

The “Penn Effect” Estimated

USD-based GDP PPP-based GDP [1] [2] [3] [4] [5] [6] [7] [8]

Pooled OLS

Between Fixed effects (Within)

Random effects

Pooled OLS

Between Fixed effects (Within)

Random effects

GDP per capita

0.259** (0.003)

0.259** (0.013)

0.387** (0.020)

0.309** (0.012)

0.317** (0.005)

0.309** (0.025)

0.386** (0.020)

0.361** (0.013)

Constant -.023** (0.008)

-.040 (0.044)

- .099** (0.036)

-.147** (0.010)

-.184** (0.055)

- -.084* (0.037)

Adjusted R2 0.564 0.677 0.800 0.564 0.413 0.467 0.800 0.413 F-test statistic

33.557** 54.362**

Hausman test statistic

19.013** 0.167

Number of observations

4600 4600

The “Penn Effect” Illustrated (I)

-4

-3

-2

-1

0

1

2

-5 -4 -3 -2 -1 0 1 2

Relative per capita income in PPP terms

Relative price level

China 2006

China 1975

The “Penn Effect” Illustrated (II)

-4

-3

-2

-1

0

1

2

-7 -6 -5 -4 -3 -2 -1 0 1 2

Relative per capita income in USD terms

Relative price level

China 2006

China 1975

Observations

• The 2005 CNY is about 1.5 standard errors from conditional mean, so statistically not misaligned

• But the point estimate indicates a 50% (!) undervaluation (in log terms)

• If one changes the definition of undervaluation as (e.g.) 3 consecutive years of misalignment, not much changes since ρ ≈ 0.95

Investigating China’s Trade Elasticities

-40

0

40

80

120

160

200

240

280

90 92 94 96 98 00 02 04 06

TradeBalance

China-US GoodsTrade Balance

Multilateral Trade Elasticities

• Standard static imperfect substitutes approach.• Analysis conducted on quarterly frequency, over

1993-06 period.• Sample period largely dictated by data

availability (changes in data collection).• y, y* are real GDP, q is CPI deflated, z is supply

variable, w additional demand factor

Chinese Exports

0

200

400

600

800

1,000

1,200

1994 1996 1998 2000 2002 2004 2006

Total Exports

OrdinaryExports

Proc. &Parts

Two (Recurring) Problems

• Chinese export data don’t match rest-of-world import data, vice versa

• No Chinese deflators, pre-2005

• We rely on the Chinese data for multilateral exports, imports

• We try various proxies as deflators

Proxies for Export Deflators

-.10

-.05

.00

.05

.10

.15

.20

1994 1996 1998 2000 2002 2004 2006

PPI

GLUK

HK UV

Panel A: Aggregate Exports [1] [2] [3] PPI GLUK HK UV

y* 5.23*** 5.30*** 6.01*** (0.29) (1.42) (0.35)

q -1.63*** -2.14*** -1.69*** (0.39) (0.68) (0.47)

Adj.R2 0.89 0.76 0.88 SER 0.186 0.272 0.223

Sample 93Q3-06Q2 93Q3-04Q2 93Q3-06Q2

Panel B: Ordinary Exports PPI GLUK HK UV

y* 4.98*** 4.82*** 5.76*** (0.32) (1.52) (0.38)

q -1.46*** -2.00*** -1.51*** (0.42) (0.73) (0.50)

Adj.R2 0.85 0.68 0.84 SER 0.209 0.293 0.244

Sample 93Q3-06Q2 93Q3-04Q2 93Q3-06Q2

Panel C: Processing and Parts Exports PPI GLUK HK UV

y* 5.35*** 5.14*** 6.13*** (0.27) (1.15) (0.33)

q -1.86*** -2.68*** -1.92*** (0.37) (0.56) (0.45)

Adj.R2 0.92 0.84 0.90 SER 0.171 0.220 0.208

Sample 93Q3-06Q2 93Q3-04Q2 93Q3-06Q2

Panel A: Aggregate Exports [1] [2] [3] PPI GLUK HK UV y* 0.57 -0.56 0.31 (0.40) (0.53) (0.40) q -0.06 0.26 0.27 (0.23) (0.22) (0.22) z 1.68*** 2.35*** 2.06*** (0.16) (0.16) (0.15) Adj.R2 0.98 0.98 0.99 SER 0.077 0.080 0.076 Sample 93Q3-06Q2 93Q3-04Q2 93Q3-06Q2 Panel B: Ordinary Exports PPI GLUK HK UV y* 0.04 -1.26 -0.22 (0.55) (0.75) (0.55) q 0.31 0.61* 0.64* (0.32) (0.31) (0.32) z 1.83*** 2.51*** 2.22*** (0.22) (0.22) (0.22) Adj.R2 0.96 0.96 0.97 SER 0.106 0.108 0.105 Sample 93Q3-06Q2 93Q3-04Q2 93Q3-06Q2 Panel C: Processing and Parts Exports PPI GLUK HK UV y* 0.98*** 0.26 0.72** (0.30) (0.32) (0.31) q -0.47** -0.62*** -0.14 (0.19) (0.16) (0.18) z 1.52*** 1.99*** 1.91*** (0.11) (0.10) (0.11) Adj.R2 0.92 0.99 0.99 SER 0.065 0.060 0.062 Sample 93Q3-06Q2 93Q3-04Q2 93Q3-06Q2

Observations

• Holding z constant results in really high income elasticity estimates, wrong sign on exchange rate.

• For aggregate exports, only z matters.• For ordinary exports, income is

insignificant, while others come in significantly

• Processing and parts exports fit quite well• All results sensitive to inclusion of trend

Chinese Imports

0

100

200

300

400

500

600

700

800

900

1994 1996 1998 2000 2002 2004 2006

Total Imports

OrdinaryImports

Proc. &Parts

Proxies for Import Deflators

-.15

-.10

-.05

.00

.05

.10

.15

.20

.25

1994 1996 1998 2000 2002 2004 2006

PPI

GLUK

HK UV

Panel A: Aggregate Imports [1] [2] [3] PPI GLUK HK UV y 1.78*** 1.41*** 2.16*** (0.06) (0.04) (0.06)

q 1.48*** 0.39** 1.54*** (0.38) (0.19) (0.32)

Adj.R2 0.99 0.98 0.99 SER 0.056 0.050 0.055

Sample 94Q4-06Q2 94Q4-04Q2 94Q4-06Q2 Panel B: Ordinary Imports

PPI GLUK HK UV y 2.16*** 2.40*** 2.54*** (0.26) (0.32) (0.27)

q 2.75** 2.25** 2.80** (1.18) (1.06) (1.19)

Adj.R2 0.85 0.94 0.94 SER 0.209 0.152 0.196

Sample 94Q4-06Q2 94Q4-04Q2 94Q4-06Q2 Panel C: Processing and Parts Imports PPI GLUK HK UV

y 1.68*** 0.85*** 2.06*** (0.08) (0.13) (0.06)

q 1.15*** -0.25 1.20*** (0.35) (0.34) (0.28)

R2 0.98 0.88 0.99 SER 0.072 0.080 0.060

Sample 94Q4-06Q2 94Q4-04Q2 94Q4-06Q2

Some Observations

• Aggregate, ordinary imports have wrong signed price elasticities

• Processing and parts imports only slightly better behaved

Alternative Import Specification

Panel D: Processing and Parts Imports PPI GLUK HK UV y -0.40* -1.86* -0.04 (0.20) (0.93) (0.25)

q -0.13 -1.64*** -0.16 (0.23) (0.58) (0.22)

w 1.10*** 1.20*** 0.96*** (0.13) (0.40) (0.12)

Adj.R2 0.99 0.89 0.99 SER 0.037 0.074 0.035

Sample 94Q4-06Q2 94Q4-04Q2 94Q4-06Q2

• Since others have suggested a link between parts imports and exports, we include total exports, w

• This yields more intuitive estimates for the exchange rate elasticity

Implications for Policy (I)

Multilateral basis, 10% appreciation leads to

• A decline of imports by 70 bn

• A rise in the TB of 15 bn

• Zeroing out the perverse elasticity leads to a decline in the TB of 46 bn

• 2006 TB was 956 bn (2000$)

• ( < $86 bn in Marquez-Schindler)

• A decline of exports by 25 bn (2000$)

Bilateral Trade Elasticities

• The standard equation augmented with a trade weighted ex-U.S. real exchange rate variable

• The q is now CNY/USD (CPI deflated)

• We examine both Chinese and US measures of China-US trade

Chinese Exports to U.S.

0

50

100

150

200

250

300

350

1994 1996 1998 2000 2002 2004 2006

US data

Chinesedata

What Accounts for the Differences?

• For Chinese exports, Chinese record as f.o.b., US reports as c.i.f.

• Chinese goods transiting HK might or might not be correctly attributed to China

• Value added in HK might be improperly attributed to China

(see e.g., Schindler and Beckett, 2006)

Proxies for Chinese-U.S. Export Deflators

-.15

-.10

-.05

.00

.05

.10

.15

.20

92 94 96 98 00 02 04 06

PPI

Composite

HK UV

CNY/USD Real Exchange Rate

4

5

6

7

8

9

10

11

12

13

86 88 90 92 94 96 98 00 02 04 06

AdjustedNominalCNY/USD

AdjustedReal CNY/USD

Note: “Adjusted” indicates nominal exchange rate takes into account transactions taking place at floating rate.

Chinese Bilateral Export Elasticities

U.S. Data Chinese Data [1] [2] [3] [4] [5] [6] PPI P HK UV PPI P HK UV

y* 0.03 0.59 0.56 -1.75* -1.19 -0.62 (0.80) (0.73) (0.75) (0.99) (0.92) (0.99)

q 0.80*** 1.27*** 1.05*** 1.55*** 2.03*** 1.65*** (0.22) (0.22) (0.20) (0.30) (0.29) (0.31)

q~ 0.47 0.68 1.04 1.31 1.52 1.08 (0.72) (0.67) (0.71) (0.88) (0.89) (0.80) z .82*** 2.14*** 2.04*** 3.12*** 3.45*** 2.98*** (0.32) (0.31) (0.33) (0.47) (0.45) (0.46)

Adj.R2 0.99 0.99 0.99 0.99 0.99 0.99 SER 0.040 0.039 0.042 0.049 0.048 0.048

Sample 93Q4-06Q2

93Q4-06Q2

93Q4-06Q2

93Q4-06Q2

93Q4-06Q2

93Q4-06Q2

Chinese Imports from U.S.

0

10

20

30

40

50

60

70

1994 1996 1998 2000 2002 2004 2006

US data

Chinesedata

Proxies for Chinese-U.S. Import Deflators

-.15

-.10

-.05

.00

.05

.10

.15

.20

92 94 96 98 00 02 04 06

PPI

US capitalgoods exportsdeflator

HK UV

Chinese Bilateral Import Elasticities

U.S. Data Chinese Data [1] [2] [3] [4] [5] [6] PPI P HK UV PPI P HK UV y 1.45*** 2.02*** 1.85*** 1.24** 1.81*** 1.65*** (0.33) (0.35) (0.32) (0.46) (0.48) (0.45)

q -1.31*** -1.13*** -0.99*** 0.25 0.43 0.57 (0.33) (0.32) (0.32) (0.39) (0.42) (0.45)

q~ -0.26 0.69 -0.21 0.36 1.32 0.42 (1.06) (1.10) (1.04) (1.51) (1.56) (1.51)

Adj.R2 0.95 0.96 0.97 0.95 0.96 0.97 SER 0.101 0.101 0.100 0.087 0.091 0.087

Sample 94Q4-06Q2

94Q4-06Q2

94Q4-06Q2

94Q4-06Q2

94Q4-06Q2

94Q4-06Q2

Implications for Policy (II)

A 10% real appreciation of CNY/USD results in

• 33 bn (2000$) reduction in trade balance

• The 2006 China-US trade balance was 229 bn (2000)

• No necessary implication for overall US trade deficit

Next Tasks

• Formal calculation of misalignment probabilities

• Checking for sensitivity to additional regressors

• Alternative measures of rest-of-world GDP (export weighted GDP, world imports)