RMB Undervaluation and Appreciation

The bilateral real exchange rate between Chinese renminbi (RMB) and the US dollar is studied. The panel Penn effect model shows that the RMB was undervalued after 1994 when China reformed its exchange rate system. It was undervalued by 64% in 2013. RMB was undervalued not only relative to the US dollar, but also relative to the currencies of all other developing and emerging countries. An examination of the appreciation of 17 currencies of the countries and areas that experienced the Penn effect shows that the RMB should appreciate at an annual speed of 3.4%. At this rate, the RMB misalignment in 2013 will be reduced by half by 2020. In the future, if the interests of both China and the US are considered, RMB appreciation should be realized totally from the nominal exchange rate, not partly from the nominal exchange rate and partly from the relative price level as it did in the past.