The Hindu : Business : China's latest decision signals flexibility
The Hindu : Business : China's latest decision signals flexibility
Date:25/07/2005 URL: http://www.thehindu.com/thehindu/biz/2005/07/25/stories/2005072500361500.htm
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Business
FINANCIAL SCENE
China's latest decision signals flexibility
Close to Indian model of exchange rate management
--------------------------------------------------------------------------------
Despite the revaluation, the dollar's influence over Chinese exchange rate management strategy will remain strong.
--------------------------------------------------------------------------------
LAST THURSDAY's announcement by the People's Bank of China of a 2.1 per cent revaluation of the yuan, also known as the renminbi (RMB) might have fallen short of market expectations as many economists had been forecasting a revaluation of 10 per cent or even more. Yet the fact that China is finally revaluing its currency after resisting pressures from the U.S. and others is by itself big news.
Even more significant is the accompanying announcement that China is substituting the dollar linkage with one based on a basket of trade-weighted currencies of its trading partners. Although the American dollar is certain to have a large weight in the basket, it is clear that the days of the fixed dollar peg are over. The yuan will be allowed to float within a narrow band of plus or minus 0.3 per cent around the currency parity calculated by the central bank on the basis of the previous day's closing rates.
All these by no means indicate a downgrading by China of the American currency. Newspaper headlines proclaiming the abandonment of the dollar peg may be technically correct but are misleading: the U.S. dollar's influence over Chinese (or for that matter Indian on any other country's) exchange rate management strategy will continue to be strong. The U.S. economy may be saddled with the twin burden of trade and fiscal deficits. Its currency may come under pressure from time to time but there is no way any central bank can avoid using the dollar as a reference currency.
U.S. pressures
In fact the U.S. deficits have considerable relevance for the Chinese currency revaluation. China has been running a huge trade surplus with the U.S. and Europe. Its current account surplus as a proportion of its GDP was as high as 4.2 per cent in 2004, most of it arising out of its strong export performance. Being pegged to the dollar at 8.28 for a decade since 1995, the yuan was kept at a low level. Chinese exporters therefore have had a huge advantage. As the trade balance with the U.S. and Europe moved relentlessly in favour of China, protectionist fears in the developed world were stoked. The Chinese economy has grown robustly on the back of an export led manufacturing strategy. That made China the factory to the world. Invariably that meant job losses in the U.S. and the West as many companies set up facilities in China for exporting the manufactured products back or to other countries. So strong have been those fears, that lawmakers in the U.S. have actually reimposed quotas on imports of Chinese textiles. The other reason why the U.S. deficits are relevant is this: in the process of defending the peg that keeps its currency low, the Chinese central bank was mopping up huge amounts of dollars (export remittances primarily, but also "hot money'' flows betting on a stronger yuan in the near future). Surging forex reserves were an inevitable outcome. By last count, China had $650 billion in reserves. (India has $135 billion). The major outlet for that kind money has been the U.S. treasury and bond markets.
China is not the only country to finance U.S. budgetary deficits but is certainly among the biggest. As often pointed out in India, investments by the Chinese and other central banks in U.S. government paper fetch low yields. Incidentally, with the mark up of the yuan there will be a notional loss on the holding of its dollar reserves. However the yuan revaluation will not change, at least for now, the seemingly irrational act of Asian central banks of continuing to invest in the U.S. Over the past two to three years, as the U.S. dollar lost ground against the euro and other major currencies, there were expectations that central banks will shift their investments to other currencies. But for a variety of reasons this has not happened, a possible clue to the shape of things to come post yuan revaluation.
Chinese exports may gain
There is also a strong likelihood that the relentless Chinese export drive will not slow down. This is because manufactured exports have a strong import component, of almost 40 per cent by some estimates. A costlier yuan translates into a lower import bill for the exporters who thus get a cushion. However the protectionist lobbies in the West may be mollified by the act of revaluing the Chinese currency, even if that does not translate into a significant commercial advantage.
In fact speculation is rife among analysts as to whether more currency alignments will take place in the near future. The logic here is that having moved away from a ten year old peg — a major decision — supplemental changes will become routine. Whether that happens or not, there is no doubt that the Chinese authorities get the much needed flexibility in managing the external value of their currency.
One last point that should not be missed. All the talk of moving towards a more flexible exchange rate regime should not obscure the fact that China has not loosened its controls over capital. Like the rupee, the yuan, despite its recent strengths, is not fully convertible. In fact, with the latest developments, the Chinese authorities have moved closer to the exchange rate management model developed by the Reserve Bank of India.
C. R. L. NARASIMHAN
© Copyright 2000 - 2005 The Hindu
Date:25/07/2005 URL: http://www.thehindu.com/thehindu/biz/2005/07/25/stories/2005072500361500.htm
--------------------------------------------------------------------------------
Business
FINANCIAL SCENE
China's latest decision signals flexibility
Close to Indian model of exchange rate management
--------------------------------------------------------------------------------
Despite the revaluation, the dollar's influence over Chinese exchange rate management strategy will remain strong.
--------------------------------------------------------------------------------
LAST THURSDAY's announcement by the People's Bank of China of a 2.1 per cent revaluation of the yuan, also known as the renminbi (RMB) might have fallen short of market expectations as many economists had been forecasting a revaluation of 10 per cent or even more. Yet the fact that China is finally revaluing its currency after resisting pressures from the U.S. and others is by itself big news.
Even more significant is the accompanying announcement that China is substituting the dollar linkage with one based on a basket of trade-weighted currencies of its trading partners. Although the American dollar is certain to have a large weight in the basket, it is clear that the days of the fixed dollar peg are over. The yuan will be allowed to float within a narrow band of plus or minus 0.3 per cent around the currency parity calculated by the central bank on the basis of the previous day's closing rates.
All these by no means indicate a downgrading by China of the American currency. Newspaper headlines proclaiming the abandonment of the dollar peg may be technically correct but are misleading: the U.S. dollar's influence over Chinese (or for that matter Indian on any other country's) exchange rate management strategy will continue to be strong. The U.S. economy may be saddled with the twin burden of trade and fiscal deficits. Its currency may come under pressure from time to time but there is no way any central bank can avoid using the dollar as a reference currency.
U.S. pressures
In fact the U.S. deficits have considerable relevance for the Chinese currency revaluation. China has been running a huge trade surplus with the U.S. and Europe. Its current account surplus as a proportion of its GDP was as high as 4.2 per cent in 2004, most of it arising out of its strong export performance. Being pegged to the dollar at 8.28 for a decade since 1995, the yuan was kept at a low level. Chinese exporters therefore have had a huge advantage. As the trade balance with the U.S. and Europe moved relentlessly in favour of China, protectionist fears in the developed world were stoked. The Chinese economy has grown robustly on the back of an export led manufacturing strategy. That made China the factory to the world. Invariably that meant job losses in the U.S. and the West as many companies set up facilities in China for exporting the manufactured products back or to other countries. So strong have been those fears, that lawmakers in the U.S. have actually reimposed quotas on imports of Chinese textiles. The other reason why the U.S. deficits are relevant is this: in the process of defending the peg that keeps its currency low, the Chinese central bank was mopping up huge amounts of dollars (export remittances primarily, but also "hot money'' flows betting on a stronger yuan in the near future). Surging forex reserves were an inevitable outcome. By last count, China had $650 billion in reserves. (India has $135 billion). The major outlet for that kind money has been the U.S. treasury and bond markets.
China is not the only country to finance U.S. budgetary deficits but is certainly among the biggest. As often pointed out in India, investments by the Chinese and other central banks in U.S. government paper fetch low yields. Incidentally, with the mark up of the yuan there will be a notional loss on the holding of its dollar reserves. However the yuan revaluation will not change, at least for now, the seemingly irrational act of Asian central banks of continuing to invest in the U.S. Over the past two to three years, as the U.S. dollar lost ground against the euro and other major currencies, there were expectations that central banks will shift their investments to other currencies. But for a variety of reasons this has not happened, a possible clue to the shape of things to come post yuan revaluation.
Chinese exports may gain
There is also a strong likelihood that the relentless Chinese export drive will not slow down. This is because manufactured exports have a strong import component, of almost 40 per cent by some estimates. A costlier yuan translates into a lower import bill for the exporters who thus get a cushion. However the protectionist lobbies in the West may be mollified by the act of revaluing the Chinese currency, even if that does not translate into a significant commercial advantage.
In fact speculation is rife among analysts as to whether more currency alignments will take place in the near future. The logic here is that having moved away from a ten year old peg — a major decision — supplemental changes will become routine. Whether that happens or not, there is no doubt that the Chinese authorities get the much needed flexibility in managing the external value of their currency.
One last point that should not be missed. All the talk of moving towards a more flexible exchange rate regime should not obscure the fact that China has not loosened its controls over capital. Like the rupee, the yuan, despite its recent strengths, is not fully convertible. In fact, with the latest developments, the Chinese authorities have moved closer to the exchange rate management model developed by the Reserve Bank of India.
C. R. L. NARASIMHAN
© Copyright 2000 - 2005 The Hindu
posted by Eastlaw at Monday, July 25, 2005
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