Real Exchange Rate in China : A Long-run Perspective

This paper investigates the RMB exchange rate from a long-run viewpoint. Whether Chinas rapid economic growth brought about real exchange rate appreciation between 1975 and 2002 is empirically examined, based on a supply-side model, the BalassaSemuelson Hypothesis (BSH). The same test is conducted on Japan, Hong Kong, Korea, Malaysia, Singapore, Thailand, the Philippines, Indonesia and India. Our result indicates that the BSH only exists where the industrial structure has been upgraded and the economy has been successfully transformed from an agricultural economy to a manufacturing economy. Interestingly, China, among those where the BSH does not present, appears to be upgrading its industrial and trade structure. We then try to answer the question of why past rapid growth has no significant relationship with the RMB real exchange rate and what factors are underlying the trend of the RMB real exchange rate. We expect an appreciating trend of RMB real exchange rate in the foreseeable future, presuming that Chinas industrial upgrading process continues and the factors pertaining to the BSHs prediction, such as rise of wage rates in both tradables and nontradables, become more significant.