Research On Exchange Rate Risk In The Process Of The Development Of China’s Manufacturing Industry’s Foreign Trade

As an important variable that influence the domestic and international economic equilibrium, the impact of exchange rate on a country’s foreign trade has been one of the important areas of domestic and foreign scholars’ research. In1994, China implemented the reform of the RMB exchange rate by establishing a market-base, managed floating exchange rate system. After that, with China’s sustained and rapid economic growth and the rising foreign trade volume, the issues about RMB exchange rate were received increasing attentions in many western countries and interest groups. They complained that RMB was seriously underestimated and needed to be appreciated. On July21st,2005, the People’s Bank of China implemented "market supply and demand based, with the reference to a basket of currencies, managed floating exchange rate system". Since then, the RMB exchange rate is no longer pegged only to the U.S. dollar, and its volatility has been increased and become more flexible, keeping a continued appreciating state. By the end of late October2012, the exchange rate of RMB against the U.S. dollar was1:6.30, which has risen more than30%compared to the rate at the beginning of the reform in July2005. The researches about the impact of RMB exchange rate on China’s foreign trade are warming up at home and abroad.As one sector of the national economy, the manufacturing industry is highly open and influenced most directly by the exchange rate fluctuations. Since the reform and opening up, the foreign trade of China’s manufacturing industry has been rapidly developed with its comparative advantage. In2010, China has become the world’s second largest manufacture country against the United States. However, in recent years, with the continued appreciation of RMB exchange rate, the profits of manufacturing exports enterprises have been eroded. At the same time, due to the flexibility and floating range of the RMB exchange rate is continuously expanding, many manufacturing enterprises have to face the increasing exchange rate risk. So, it is necessary to conduct a depth research about the impact of RMB exchange rate on China’s manufacturing industry. Many literatures research on how the level of the exchange rate and the volatility of exchange rate influence on foreign trade. Considering the increasing RMB exchange rate expectation, this paper aims to analyze the RMB exchange rate risk influence on China’s foreign trade of manufacturing industries in long and short-term, from the view of the level of RMB exchange rate, exchange rate volatility and exchange rate expectation. It concerns about not only the changes in the total trade volume and segments trade volume, but also the dynamic changes of the manufacturing industry’s import and export structure. The paper will deepen the understand of the impact the exchange rate risk on manufacturing industries,providing a theoretical evidence for the optimization and adjustment of industrial structure in practice and guiding manufacturing industry to improve factor endowments and realize upgrading.This dissertation consists of the following six chapters. Chapter1is an introduction. It describes the research background and significance, and then reviews related theories and existing research literatures. On this basis, the paper illustrated the main structure and research methods, and points out the innovation and deficiencies.Chapter2presents the development of China’s manufacturing industry based on the perspective of comparative advantage. The results show that most export comparative advantage of manufacturing products in China still mainly concentrates in labor-intensive products, although their comparative advantage index showing a downward trend in recent years, but they still have obvious comparative advantage. Some high-tech products have certain extent of comparative advantages in the world market, particularly some products show strong or significant comparative advantage. Overall,the comparative advantage of China’s manufacturing industry still reflects in labor factor and upgradation of factor endowments promote the optimization of trade structure in a certain extent.Chapter3analyzes exchange rate risk faced by manufacturing industry in the open economy. This chapter firstly analyzes RMB exchange rate system evolution with comparative advantage, and then the chapter researches the relationship between RMB exchange rate changes and manufacturing industry under the frame of Balassa-Samuelson effect theory. The results show that the improvement of manufacturing sector relative labor productivity will increase RMB real exchange rate appreciation in the long term,which means the Balassa-Samuelson effect works in China.At the same time, we estimate RMB exchange rate risk in this chapter. Since the increasing of the range of exchange rate volatility along with the appreciation process of RMB, exchange rate risk has a greater impact on foreign trade of the manufacturing industry gradually.Chapter4makes an empirical anallysis of the dynamic relationship between RMB exchange rate risk and manufacturing exports.Based on the behavior of consumers and manufacturing exports vendors, this chapter constructs a theoretical export trade model at the micro level.Then the chapter expands the basic model with introduction of exchange rates fluctuation risk and exchange rate expectations due to the exchange rate uncertainty. By using vector error correction model,the paper measures the long and short-term impact of RMB exchange rate risk on total manufacturing exports, exports of industry segments, as well as export structure. The results show that:in the long term,the level of RMB exchange rate of and the risk of exchange rate volatility have a significant negative impact on the total exports of the manufacturing industry, while the RMB exchange rate expectation has significant positive impact on it, which will offset the negative impact of decline in exports by the appreciation of exchange rate. In the short term, RMB exchange rate risk dose not show a significant negative impact on manufacturing exports. Whether in long-term or short-term, RMB exchange rate, exchange rate volatility and exchange rate expectation have various impacts on different industries exports. And from the combined effects, the impact on the export of labor-intensive products is relatively larger than on the exports of capital-intensive products.Chapter5offers an empirical study of the dynamic relationship of the RMB exchange rate risk and manufacturing imports. Firstly, this chapter constructs a theoretical import trade model from import demand and import supply, then it estimates the impact of RMB exchange rate risk on total manufacturing imports, manufacturing industry segments and import structure in long and short-term. The results show:the appreciation of RMB exchange rate, exchange rate risk, and the exchange rate appreciation expectation will have significant negative impact on the total manufacturing imports in the long-term, while in the short-term, the impact of RMB exchange rate and exchange rate expectation on total manufacturing imports seems uncertain, and the risk of fluctuations in exchange rates does not show a significant negative effect. Exchange rate appreciation as well as the risk of exchange rate volatility has slightly larger negative impact on imports of labor-intensive products than the capital and technology-intensive products. Compared with the conculsions of chapter4, it can be found that the level of RMB real exchange rate has isotropic impact on China’s manufacturing export and import trade, while the risk of exchange rate volatility has negative impact on manufacuringthe import and export in most of the time, while exchange rate appreciation expectation has inconsistent impact on manufacturing exports and imports.Chapter6is mainly about conclusions and policy recommendations.This chapter draws a comprehensive summary of the main points and conclusions of the paper. Then it discusses China’s manufacturing industry how to promote the development of foreign trade by adapting to comparative advantage. In the end, the paper puts forward related policy recommendations and countermeasures about how to manage and prevent exchange rate risk.This dissertation is innovative in the following areas:(1) Based on researching the relationship of manufacturing industry and RMB exchange rate as well as considering comparative advantage, the paper selects exchange rate risk perspective to study the impact of exchange risk on foreign trade of China’s manufacturing industry, therefore indirectly reflecting the impact of exchange risk on manufacturing industry. It’s a relatively new perspective.(2) When analyzing the impact of exchange rate risk on manufacturing foreign trade, the paper constructes theoretical models for the import and export based on the behavior of consumers and manufacturers, and expand the models through introducing new variables. Furthermore, the paper not only takes into account the traditional variables such as exchange rate and exchange rate volatility in the model,but also takes into account RMB exchange rate expectation in the model.(3) The dissertation conducts a comprehensive and systematic study on dynamic relationship between exchange rate risk with foreign trade of manufacturing industry from different levels, and it argues that the introduction of exchange rate expectations helps to enhance the explanatory power of the real economy.