The consumption effect of the renminbi appreciation in rural China UNCTAD-Vi Trade and Poverty Analysis 2014 Dahai Fu a and Shantong Li b a Central University of Finance and Economics (Beijing, China) b Development Research Center of the State Council of China

Introduction 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. 2

Motivation Policy reform Exchange rate reforms launched by the Chinese authorities in July The Renminbi has been appreciating over 30% and the trend continues. 3 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) Poverty reduction in China 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. 4

Motivation (cont’d) Public debate 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. 5

Research questions What does the recent appreciation of the renminbi mean for the poor in China? Has the appreciation of the renminbi lowered expenditures and hence made Chinese households better off? Has it favored the poor or rich households in China? 6

How may the exchange rate movements affect the poor? 7 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) Channel 3: the real exchange rate effect 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. 8

Methodology and Data Estimate the impact of the RMB appreciation on consumer prices of 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. 9 Exchange rate movements Consumer prices Consumption expenditure ①②

Marketization Index for China’s Provinces 10 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 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) 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). 11 Exchange rate movements Consumer prices Consumption expenditure ①②

Findings (I) Estimations of the exchange rate pass-through to consumer prices 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). 12

Findings (II): pro-rich bias The average welfare gain from a 10% appreciation amounts to 1.4% of household expenditure. Rich households derive larger benefits from the RMB appreciation than poor households (pro-rich bias). 13

Why the poor gain less? Poor households spend less on food and housing, which become cheaper as a result of the appreciation. But, they usually spend more on medical care, the price of which has not decreased following the appreciation. 14

Findings (III) No big difference in welfare gains between poor and rich households in the coastal provinces. In the inland provinces, the welfare gains of the richest households are about twice that of the poorest households. 15

Findings (IV) The effects of appreciation are greater in coastal areas than in inland provinces, conditional on per capita household income. 16

Conclusion The ERPT is incomplete and heterogeneous across the goods and provinces. The ERPT is higher for consumer prices of food and housing and in provinces with more developed market economy. All the residents gain from the RMB appreciation in terms of the consumption expenditure but the poor benefit less. The residents living in the coastal region with highly-developed market economy gain more. 17

Caveats Only examined the impact of the exchange rate changes on household welfare that occurs through the consumption channel rather than income channel. Only estimate the direct effect of price changes induced by the appreciation, disregarding the substitution effects due to the relatively aggregate consumption data. 18

Policy recommendations Anti-poverty policies should take into account regional heterogeneity - such as consumption patterns of residents and the development level of the market economy. 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. 19

Policy recommendations 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. 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. 20

Questions and Comments? 21