The Impact Of FDI On The Real Exchange Rate Of RMB

The reform of exchange rate of RMB is announced by the central bank on July21,2005, which caused the continuous appreciation of RMB. The real exchange rate is affected by FDI through two difference channels. The first one is the impact of FDI on the short-term changes in real exchange rate of RMB. And the second one is the impact of FDI on the long-term changes in real exchange rate of RMB.FDI may lead to a real exchange rate appreciation or depreciation, depending whether FDI is used to domestic spending or capital accumulation in the trades or in the non-traded sector. This paper examines the FDI in China during1990to2009and the empirical results argue that these large inflows of foreign capital are the main determinants of the real exchange rate appreciation. This is the first channel.FDI is an important channel of international technology diffusion. If FDI increase, it will raise productivity of host country, causing technological progress. The empirical results show that FDI primarily promote technological progress in China via the direct effect rather than technology spillovers.Balassa and Samuelson argued that productivity growth in the traded goods sector tends to be much higher than in the non-traded goods sector, and therefore the relative price of traded to non-traded goods tends to rise quickly. The real exchange rate is defined as the relative price of traded to non-traded goods. In fact, the real exchange rate is affected not only by productivity, but also by other factors. Thus, the paper applies the new model to the RMB/dollar real exchange rate based on the Balassa-Samuelson model. The empirical results prove the new Balassa-Samuelson model. If productivity growth in the traded goods sector tends to be much higher than in the non-traded goods sector, the real exchange rate will be appreciation. What’s more, the real exchange rate is also affected by term of trade. So if FDI increase, productivity will raise, causing the real exchange rate appreciation. This is the second channel.