Erroneous reports on yuan

IMF's views on the exchange rate being widely popularized by media in the West to mislead public in their countries

The International Monetary Fund published its quarterly World Economic Outlook on Oct 9, assessing the prospects for the global recovery in the light of such risks as the ongoing eurozone crisis and the "fiscal cliff" facing the United States.

It has also lowered growth expectations for emerging markets and developing economies where activity has been slowed by their policy tightening in response to capacity constraints and weaker demand from advanced economies.

The WEO, which was unveiled ahead of the IMF-World Bank 2012 Annual Meetings in Tokyo, has as usual drawn a high degree of attention.

For China, what is particularly eye-catching is the forecast data contained in the report about China's gross domestic product measured in yuan and US dollars, two measurements that can be used to directly calculate the exchange rate of the yuan against the dollar. According to the two measurements, the yuan will decline in value against the dollar over the next five years, with the exchange rate between the two declining from 6.3251 yuan to $1 this year to 6.6793 yuan to $1 in 2017, a total depreciation of about 5.3 percent.

But then bewilderingly the report also says that the yuan, along with some other currencies, is still underestimated.

That the yuan is underestimated is a view that has been repeated many times by the IMF in recent years.

In its Staff Report for the 2011 Article IV consultation for China, issued in July 2011, the IMF said that the yuan's exchange rate was seriously underestimated. In a similar report released in July this year, the IMF claimed the Chinese currency was still moderately underestimated. However, the Chinese government's view is the yuan's exchange rate is already near equilibrium.

As an important international financial agency, the IMF is tasked with the responsibility of monitoring the currency exchange rates of all member states. Regrettably, the assessment of the yuan's exchange rate in the latest IMF report does not make sense.

If the yuan is moderately underestimated, as the latest IMF report claims, then why does it still forecast the Chinese currency will depreciate in the coming years? Or to put it the other way, if the yuan is expected to face continuing depreciation in coming years, why is it still believed moderately underestimated? Is there something wrong with the methods employed by the IMF for the assessment of the yuan's exchange rate or has its forecasting gone awry?

The IMF usually bases its forecasts about a country's currency exchange rate on the assumption that the currency's real effective exchange rate, which is largely decided by its nominal exchange rate and the country's price level, will remain stable. Using this method of calculation, the yuan's nominal exchange rate will surely decline if the IMF assumes its real effective exchange rate will maintain stability, given the IMF's prediction that the rise of China's consumer prices will remain higher than other main currency-issuing countries over the next five years.

Such reasoning may partly explain why the IMF has made mutually conflicting arguments about the yuan's exchange rate. The problem is the IMF's conclusion that the yuan's real effective exchange rate will remain stable is in obvious contradiction with its appreciating tendency over the past few years.

In its previous world economic outlook reports, the IMF has always forecast that the ratio of China's current account surplus to its gross domestic product will rise, but such a prediction has always proved wrong.

Worse, the IMF's erroneous forecasts about the yuan's exchange rate have been utilized by some think tanks in the United States as the basis to assess the magnitude of the yuan's so-called underestimation and its effects on US jobs. Such "negative effects" have been widely popularized by the Western media, misleading the public in the US and elsewhere.

The IMF's assessment of the yuan's exchange rate as underestimated and its forecasts about the rising ratio of China's current account surplus to its GDP have been used as theoretical support by some countries seeking to pressure China to appreciate the yuan. As the IMF is considered by many ordinary people to be an authoritative international financial institution, such a practice makes it easy to mislead them. China should forcibly refute the IMF's argument to prevent people around the world from being misled.

The author is a researcher with the China Center for International Economic Exchanges.