Over the last decade, many foreign firms have invested in China and used their Chinese factories to produce goods for export. If the yuan is allowed to float freely against the US dollar on the foreign exchange markets and appreciates, how might this affect the fortunes of those enterprises?
China focused on pegging the value of the yuan to the US dollar to make the currency more stable. The strategy worked during a long period of time, and it resulted in the rapid economic growth within the country because of the increased investments. However, the yuan remained to be undervalued by 40% in relation to the pegged exchange rate. Foreign firms invest in Chinese enterprises because of the comparative cheapness of labor, which is the result of the followed economic strategy.
If the yuan is allowed to float freely against the US dollar on the foreign exchange markets, the costs associated with the labor of the Chinese workers will increase significantly about the new rate of the yuan. As a result, it can become disadvantageous for foreign firms to invest in Chinese factories. The industries of China work for export as the priority of market development, and the change in the rate can lead to a decline in the invested industries. The demands for export will also decrease because of alternations in the prices of Chinese goods.
How might a decision to let the yuan float freely affect future foreign direct investment flows into China?
The yuan which floats freely against the US dollar can grow in its value, but the economic perspectives for the investors can also change. Today, foreign direct investment flows into China are caused by the necessity to sponsor the Chinese enterprises which produce cheap goods for export. The cheapness of goods depends on the costs spent on labor and materials. The current rate of the yuan guarantees the comparative cheapness of the production process. The increase in the yuan’s value makes the benefits of investing in China less obvious for foreign firms. The investors can begin to seeking for more beneficial markets to meet their economic interests. That is why it is possible to speak about the potential decrease in the investment rate.
Under what circumstances might a decision to let the yuan float freely destabilize the Chinese economy? What might the global implications of this be?
The Chinese economy significantly depends on the rates in exports. Any changes in the yuan’s value can affect the country’s export. Today, it is rather difficult for the foreign exporters to compete with the cheap Chinese products, that are why the question of the yuan’s rate is discussed. In this situation, the growth of the yuan’s value can have two opposite consequences. On the one hand, the export rates can decrease because of the associated changes in the global market.
On the other hand, the increased value of the yuan can stimulate the further development of the country’s economy about the other spheres. The potential of the Chinese goods to compete within the global market under the new circumstances is the controversial question. To avoid the significant destabilization of the economy, it is necessary to realize the changes in the currency’s control gradually. It is important to decrease the production cost risks to contribute to further investors’ interest in the Chinese economy with references to the rather strong yuan.