Transcript The consumption effect of the renminbi appreciation in rural China

The consumption effect of
the renminbi appreciation
in rural China
Dahai Fu a and Shantong Li b
Central University of Finance and Economics
(Beijing, China)
Development Research Center of the State Council
of China
a
b
UNCTAD-Vi Trade and Poverty Analysis 2014
Introduction
2

My cooperating policymaker: Ms. Li, Shantong

Professor Li is a senior research fellow at Development
Research Center (DRC) of the State Council, P.R. China.
She is the former director general of the Development
Strategy and Regional Economy of the DRC.
Motivation
3

Policy reform

Exchange rate reforms launched by the Chinese authorities in July
2005. The Renminbi has been appreciating over 30% and the trend
continues. 140
130
120
110
USD/RMB
CPI
100
90
Source: Authors’ calculations ,based on data from the International Financial Statistics, Bank for
International Settlements and United States Federal Reserve Bank of St. Louis.
Motivation (cont’d)
4
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Poverty reduction in China
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
China’s achievement in reducing poverty during the reform era has
been remarkable.
China still having the world’s second-largest poor population in
absolute terms after India.
Motivation (cont’d)
5
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Public debate
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The impact of the renminbi appreciation on the country’s trade
flows, labour market and economic growth has been widely
analyzed.

But, the effects of exchange rate movements on consumers and
poverty in China has not yet been studied in the existing literature.

The few responses have come in the form of opinions rather than
hard evidence.
Research questions
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
What does the recent appreciation of the renminbi mean for
the poor in China?
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Has the appreciation of the renminbi lowered expenditures
and hence made Chinese households better off?
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Has it favored the poor or rich households in China?
How may the exchange rate movements
affect the poor?
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
Channel 1: price transmission

Exchange rate movements directly affect the prices of imported
intermediate and finished goods.

Exchange rate pass-through (ERPT): the percentage change in
domestic price measures resulting from a one percent change in
the nominal exchange rate.
Channel 2: exchange rate fluctuation could result in
fluctuation in output, which has an impact on the incomes of
the poor.
How may the exchange rate movements
affect the poor? (cont’d)
8

Channel 3: the real exchange rate effect
e R  E 

P
P*
The real exchange rate influences the country’s external
competitiveness and hence its growth rate, which can affect the
poor in the long term through reduced employment opportunities
and wages.
Methodology and Data
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Exchange rate
movements

①
②
Consumer prices
Consumption
expenditure
Estimate the impact of the RMB appreciation on consumer prices of
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different goods (food, clothing, transportation and communication,
medical care, education, housing, durable goods)
different regions (22 provinces in China)
by controlling for index of “marketization” to capture the regional
heterogeneity in exchange rate pass-through, which is time-varying
and could be better capture the heterogeneous responses to external
shock.
Marketization Index for China’s Provinces
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The Index measures the relative position in the progress towards market economy
compared to other provinces.

The Index comprises 19 indicators of institutional arrangements and policies in 5
major areas with the market-oriented reform (Government and market; The
ownership structure; Goods market development; factor market development; The
legal framework).
Methodology and Data
11
Exchange rate
movements
①
②
Consumer prices
Consumption
expenditure

Simulate the impact of price changes on household welfare through
consumption.

Consumption structure of households in different regions are calculated
using 2002 China Household Income Project Survey (Rural areas)
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Non-parametric regressions are used to describe how changes in the
prices of final consumption goods affect the different types of households
following Deaton (1989).
Findings (I)
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Estimations of the exchange rate
pass-through to consumer prices
0.20
0.10
0.00

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Incomplete and varies substantially
across products and regions.
Consumer prices of food and housing
expenditure are relatively more
response to exchange rate changes.
Consumer prices seem to be more
responsive to exchange rate changes in
provinces with a high marketization
index (coastal regions).
Average ERPT

-0.10
-0.20
-0.30
-0.40
-0.50
-0.60
Findings (II): pro-rich bias
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The average welfare gain from a 10% appreciation amounts to 1.4% of
household expenditure.
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Rich households derive larger benefits from the RMB appreciation than
poor households (pro-rich bias).
Why the poor gain less?
14
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Poor households spend less on food and housing, which become
cheaper as a result of the appreciation.
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But, they usually spend more on medical care, the price of which
has not decreased following the appreciation.
Findings (III)
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No big difference in welfare gains between poor and rich households in
the coastal provinces.
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In the inland provinces, the welfare gains of the richest households are
about twice that of the poorest households.
Findings (IV)
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The effects of appreciation are greater in coastal areas than in inland
provinces, conditional on per capita household income.
Conclusion
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The ERPT is incomplete and heterogeneous across the goods and
provinces.
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The ERPT is higher for consumer prices of food and housing and in
provinces with more developed market economy.
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All the residents gain from the RMB appreciation in terms of the
consumption expenditure but the poor benefit less.
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The residents living in the coastal region with highly-developed
market economy gain more.
Caveats
18
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Only examined the impact of the exchange rate changes on
household welfare that occurs through the consumption channel
rather than income channel.
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Only estimate the direct effect of price changes induced by the
appreciation, disregarding the substitution effects due to the
relatively aggregate consumption data.
Policy recommendations
19
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Anti-poverty policies should take into account regional
heterogeneity - such as consumption patterns of residents
and the development level of the market economy.
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The government should pay more attention to the
fundamental factors such as excessive issuance of currency,
increasing market demand and supply costs that drive
domestic inflation, in addition to keeping a more flexible
exchange rate regime.
Policy recommendations
20
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Social safety nets should be extended to cover more rural
residents. More health care and education subsidies should
be given to them. Policies favorable to growth in agriculture
and lifting of restrictions on migration will relive the pressure
on the social safety net.
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Given the limited welfare gains through the consumption
channel, the government should pay attention to labour
market effects that are also likely to substantially affect the
poor.
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Questions and Comments?