Exchange Rates and Production Networks in Asia: A Twenty-first Century Perspective

Abstract

ABSTRACTChina's surplus in processing trade, correctly measured, approaches half a trillion dollars year after year. Processed exports are final goods produced using parts and components imported from East Asia. Cointegration evidence indicates that processed exports depend, not only on the renminbi exchange rate, but also on exchange rates in East Asian supply chain countries. Results from out-of-sample forecasts indicate that exchange rates in supply chain countries remain important for explaining processed exports over the 2013–2015 period even as China's value-added has increased. While the renminbi has appreciated by 50% between 2005 and 2015, exchange rates in South Korea, Taiwan, and Japan have depreciated or stayed the same during this period, despite large current account surpluses. In order to switch expenditures away from China's processed exports and rebalance trade, it is necessary for exchange rates in Asian supply chain countries to also appreciate.