The Financial Sector in China
It is the case of the already economic-awaken China. By opening its doors to international commerce, its exchange rate system aroused concerns from the world commodity currency of United States Dollar. Thus, the formerly fixed exchange rate Renminbi had to realize appreciation which is out of the conventional state-owned decision-making and policy. The China’s Central Bank is unwilling to accept command from the US, partly some of inherent protection to Western imperialism, rather chose to act according to its own will. Due to this, it is slowly but indirectly granting the wishes of the commodity currency through seemingly adapting some features of floating exchange rate system.
Perhaps, one of the unchallenged consequences of international trade, floating exchange rate system ensures that the economic performance of a nation will be reflected through its own currency. As in the case of the reincarnated China, foreign direct and portfolio investments serve as key contributors to its fast surging economy. A lively-active market entails inflation which in turn increases the local demand for the currency of both consumers (to buy the products) and producers (to finance capital requirements). Hence, as supply and demand law posits, its currency faces appreciation.
However, tagging the country as one of the best destinations of FDI, due to demand potential of its enormous consumers and labor-cost advantages, did little to tickle government authorities. Emanated by 8.03 to 8.02 appreciation against the dollar, such minimal increase posted the highest gain of the currency since it began revaluing Renminbi to accord international market forces. Can be viewed as highly conservative floating exchange rate system, it also recently allowed its major banks to reflect revaluation trends. But why is China so conservative to embrace the “invisible hand” of currency valuation? Is it purely political regimen to imply world power, protection of local producers/ consumers or simply adaptation flaws for a millennia-old centrally-planned form of governance?
Probably, China does not want risks to emerge abruptly parallel to its abrupt adaptation of floating system. It can lead to inflation and adverse effects to balance of payments which the state cannot act on readily because national forces widened into complex and ever-changing international forces. Rather the state wanted a smooth shift as it builds the necessary institutions to help its policies address the exchange rate issues in the future. Thus, the gradual approach of China to freely float its currency in the international arena is preferred both for the benefit of its population and install supremacy of its government against other countries.
Local producers are given the time to obtain efficiency in its operations, as reflecting the US measure of the under-priced of Renminbi could mean more expensive export merchandise detrimental to its balance of payments. In a similar way, consumers are provided with cues on what to expect to their wages and price level in the upcoming future, therefore, preventing public panic of any abrupt development. Lastly, the state avoids its political ideals to be inflicted by other customs especially to affect the minds of its citizens. This argument is concretized how the government created their own internet search engine to filter down political and “destructive” global information.
Implications
Wealthier countries have the ability to obtain substantial amount of foreign reserves to hedge unintended fluctuations in the world market. This inequality of liquidity makes poorer countries dependent to them in their economic judgment. More appropriately, poor countries acting like so when the wealthy counterpart is an important trade partner. As a result, its floating rate performance will have the same direction as the wealthy one. The problem is in the event of global recession, these poorer countries will not be saved by their partners’ mere currency harmony rather it involves the former to save its currency within its own borders.
Thus, there is little and partial advantages of both fixed and floating system for the poorer one. Trade liberalization at the international level demand its local producers to be efficient and technologically competitive to push the local BOP upward while the government is duty-bound to replenish foreign reserves for future contingencies. Globalization means independence and competitiveness of both currency and national economy. As China handles its global position, poorer countries should have the billion dollar reserves in their Treasury to obtain not only economic security put also national identity.
Spot exchange rates are risky for MNEs as the primary determinant of host country demand depends largely on the price of its goods, services, labor and entrepreneurship (GSLE). Particularly true to unstable currencies, price competitiveness of an exporting MNE is pegged on fluctuations of host country’s currency. If spot rate suggests that the host (say, Japan) currency depreciates, home MNE (say, based in US) GLSE becomes expensive since importers face a stronger dollar. When sold to end-users, adverse reactions such as added-costs without added-value or simply look at the exporter’s products as unfair may result. If the spot rate change is cyclical, the MNE is on a relatively comfortable zone. However, when fluctuations are regular and the direction is unpredictable, the submission of MNE to trade depends on how much risk it can hold. When MNE investors become anxious in achieving expected foreign cash flows, this is when hedging becomes useful.
Since forward foreign currency contracts assume that parties tend to maximize their utility, it can also predict the expected spot rate of foreign currency. This can be helpful for risk-averse MNEs especially when they are only engaging to get a break-even point or fair gains from trade. It can simply quote its desired level of foreign currency valuation with respect to its GLSE. Thus, international trade tends to be stable in both demand and supply since speculation is minimized in favor of arriving at forward rates. In the financial market, forward rates can also result for investors to continuously invest over a period of with little slack time. As a result, in-need MNEs can gain access to capital easily and readily. This will also imply that investors are less speculating rather they become more firm-specific. In effect, quality of products and efficiency can also be outcomes of forward quotations.
Credit:ivythesis.typepad.com
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