China has been labeled as a currency manipulator by members of the U.S. Congress. Its currency, the renminbi, is viewed as undervalued by as much as 40% by U.S. economists and politicians. China has resisted attempts to allow its renminbi to appreciate significantly because its economic growth is exports-based and it competes in the same markets with countries who also have undervalued currencies . China is different from India whose economy is more domestic demand-based.
Due to the Great Recession of 2007-2008, China froze its nominal exchange rate with respect to the U.S. dollar at 6.85 renminbis per one dollar. Since then, the Chinese economy has undergone much faster than the western economies including that of the United States. As a result, the rising economic superpower unfroze the nominal exchange rate in June 2010 to stave off inflation and to comply with the G-20 countries’ call for resolving the external economic imbalances. The renminbi appreciated by about 4% since then which is not really sufficient to correct imbalances, given the characterization that this currency is as much as 40% undervalued.
Under the pressure of an economic growth that may have exceeded 10% in 2010, the Chinese economy came under an inflationary attack which currently exceeds a 5.1% rise in CPI, compared to about 0.6% in the United States. This rising and uncomfortable inflation rate was also affected by China’s refusal to let its undervalued currency appreciate much more to mitigate the impacts of import inflation. Combining the 4% appreciation in the nominal exchange rate and the 5% increase in the inflation rate, China’s real exchange rate (RER) appreciated by 9%. What matters for exports, imports and trade imbalances is the adjustment in the real and not only the nominal exchange rate.
This real exchange appreciation will continue as long China’s inflation rate keeps rising even if the nominal rate does not change as described by Professor Marin Feldstein in a presentation at the 2011 American Economic Association conference that was held in Denver during the period January 6-8, which I attended.  Therefore, if governments do not respond to market forces and let their nominal exchange rates appreciate, these forces impose an appreciation on their real exchange rates and change the exchange rate picture. At the end result, sizable appreciation in the real exchange rate should do the adjustment by reducing the imbalances in the external balance and mitigating the appreciation pressure on nominal exchange rate.
The GCC countries, which peg their currencies to the US dollar, with the exception of Kuwait, had faced this issue in 2007-2008 and resisted to let their nominal exchange rate appreciate. They suffered from rapidly rising inflation rates that reached about 13% in Qatar and Dubai, most of which was imports inflation. There were then calls on the GCC countries to un-peg their currencies from the dollar to address inflation. But those countries’ love affair with the dollar is more complicated than in the case of China. They price their oil in dollars and hope to establish a monetary union in the near future. However, analogous to China, the GCC countries’ inflation rates are rising as a result or rising oil prices.
These countries will face rising real currencies even if they keep their dollar-pegged nominal rates unchanged. No one should be under the nominal rate illusion that the GCC exchange rates are fixed or constant. The market forces are stronger the official nominal exchange rate. The GCC countries or emirates that do not directly depend much on oil revenues such as Dubai will be hurt by the rising dirham real exchange rate. It is still worth noting that the GCC countries have highly open economies which should to some extent moderate the fluctuations in their real exchange rate. In, fact, all the GCC countries can speed the adjustments of their economies by considering a surprising, swift, adequate and measured one-time appreciation in their nominal exchange rates as the economy starts to heat up. At the same time, they can maintain a crawling nominal peg.
The appreciation of the GCC countries' RERs may also create misalignments with the neighboring countries such that the current account deficit-ridden trading partners like Turkey, Jordan, Syria and Lebanon would benefit, particularly if those countries do not cling to overvalued currencies and have lower inflation rates. Iran may benefit as well despite the sanctions. The real exchange rate is one of the key determinants of exports and imports. On the other hand, the GCC officials particularly in Dubai and Qatar should watch the future trajectories of their real exchange rates as their own and world’s economic recoveries strengthen.
I call on researchers to examine the misalignment and volatility of the GCC countries’ real exchange rates on their international trade and compare their results to those that are pertinent to non oil-based economies.
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