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The Yuan: When and How Much?

 Omkar Goswami


This is the season when half of Delhi goes in search of cooler climes with or without their passports, when half of Mumbai returns to await the monsoons, and when all of Chennai drips with sweat. It a season when, with little else to do, reams of imported newsprint are devoured by “inside” stories of the great Indian filial drama — and how the mother of all kutty’s became the brother of all abba’s. It is also the season when I can’t think of anything to write about, except an article on the Chinese currency.


There are really three questions regarding the Chinese yuan or the renminbi. First, will it be allowed to appreciate? Second, by how much? And third, when?


Regarding the first question, the consensus is that China will allow the renminbi to rise. This is only partly due to the pressure being put by the US, the European Union, the G7 and, more recently, the IMF in its May 2005 Article IV consultations. More importantly, it is because China wants to portray itself a responsible global economic power — one that carries the Han man’s burden. If capturing an even greater share of world trade and investments requires a little bit of give on the exchange rate, then so be it. Revaluation, therefore, seems to be a given.


Those who matter in China’s economic and financial policy-making also agree that revaluation requires de-linking the renminbi from the US dollar and then anchoring it to a basket of currencies, comprising the US dollar, the euro and the yen. However, the mega billion dollar question is by how much. Here, the debate gets murky.


According to what one has heard, the Chinese advisors are split down the middle. The economic ‘progressives’ argue that anything less than 15 per cent is insufficient do deal with international market expectations, and prefer a clean one-shot appreciation in the region of 15 per cent. According to them, a smaller revaluation will encourage active exchange rate arbitrage. Simply put, anticipating a second round of appreciation, global  as well as overseas Chinese punters will heavily invest in yuan-backed financial assets with the expectation of booking super-normal profits at the time of the next revaluation. This would be the Chinese version of the jhatka meat approach — short, sharp, incisive and a once-and-for-all correction, followed by a calibrated float.


Arrayed against the ‘progressives’ are the ‘conservatives’, who are arguing that neither China’s financial sector nor it’s exporters can stomach a sharp shock. In January 1994, China devalued its exchange rate from 5.8 renminbis per US dollar to a limited float beginning at 8.7, and then firmly pegged to 8.278 in June 1999. Since then, China has operated on the basis of a fixed, dollar denominated nominal exchange rate. The conservatives are saying that China needs time to move to a full float, and that  gradualism is the essence of good Chinese governance. Therefore, according to this camp, first appreciate by something like 7.5 per cent to 10 per cent; then watch, wait and see what this does to exports, banks and the financial sector; thereafter, if need be, take the next steps.


It is hellishly difficult to predict what the final decision will be. But my gut tells me that we will probably see the triumph of the exchange rate conservatives over the progressives. So, without betting even a measly little nickel, I expect an appreciation in the range of 7.5-10 per cent, followed by an strictly managed, highly interventionist limited float.


Finally, there is the issue of timing. If I had even the faintest clue about it, I would have been busy figuring out to make the fortune of my lifetime instead of typing out this column. The only sense I get is that it will most likely occur within this calendar year. At that point, the focus will shift to the RBI. Will it then heave a sigh a relief and using the breathing space offered by the Chinese, let the rupee float upwards a bit more? Or will it continue to intervene to keep the rupee in the Rs.43.50 to Rs.44 band, and allow our exporters to reap some currency advantage? What do you think?


Published: Business World, June 2005


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