Is the Renminbi really undervalued?

Most commentators argue that, despite its recent revaluation, the Chinese Renminbi (RMB) is still undervalued. But in a paper prepared for a two-day San Francisco Fed conference this week, three academics "do not take a stand upon how large a revaluation – or devaluation – is necessary". Rather, Why the Renminbi Might be Overvalued (But Probably Isn’t) (PDF) by Yin-Wong Cheung, Menzie D. Chinn and Eiji Fujii discuss the Renminbi from the viewpoint of currency misalignment theory:

...in particular, we want to focus on (1) disagreements regarding what is the “equilibrium real exchange rate” in theory (and in intervention ridden economies), (2) quantifying the uncertainty surrounding the level of the equilibrium, even when the model is settled upon, and (3) discussing what the profession has learned about equilibrium exchange rates in the wake of the East Asian crises of 1997-98. In this regard, we will neglect to some degree short term analyses, and focus on the underlying and longer term determinants of exchange rates.

The Renminbi is evaluated using relative purchasing power parity (PPP), absolute PPP, and Balassa-Samuelson criteria. Cheung, Chinn and Fujii find:

..some approaches imply substantial undervaluation of the RMB, while others imply little or none. Yet a few others indicate slight overvaluation. However, even when the estimated degrees of undervaluation are large, the gap between predicted and actual values is not always statistically significant. We also find that including measures of institutions, such as the absence of corruption, results in smaller estimates of RMB undervaluation.

The paper concludes on a cautious note:

Taking all these arguments into consideration, we conclude that in the context of
several models, and over several time frames, the RMB is undervalued. But several
methodologies would indicate overvaluation, albeit of modest magnitude. Combined with
uncertainty along statistical and theoretical lines, we would recommend circumspection
in assertions of extreme RMB misalignment.

This is one of several interesting papers given at this week's Annual Conference on "External Imbalances and Adjustment in the Pacific Basin", organised by the SF Fed's Center for Pacific Basin Monetary and Economic Studies. Though the conference agenda (PDF) has embedded links to most of the papers, they don't appear to work. Those wanting to download the papers should use either Google or the following URL: http://www.frbsf.org/economics/conferences/0509/paper-####.pdf (substitute lead author's surname)

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