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China Revaluing its Currency

Omkar Goswami


Economists hate predicting anything of consequence. So let me be totally unlike my peers to stick my neck out several miles and predict something that may later make me look like a fool: “China isn’t going to revalue its currency in any significant way in the near future”. Having got that off my chest, let me now move on to the rest of the story.


I find it quite strange how some of the western nations, with the US in the lead, are trying to pressurise China to revalue (and hence appreciate) the yuan. During the Asian crisis, almost the same set of nations were pleading with China not to devalue — to hold firm to its fixed exchange rate, and thus save global trade from a cuurency crisis brought about by competitive devaluation. When China stuck to its fixed exchange rate of 8.27 yuan to a US dollar, every trade and finance minister throughout OECD and ASEAN praised the country for honourably discharging its global responsibility. Five years later, the same chaps who wanted China to remain on a fixed exchange peg, want it to float and appreciate its currency!


There is no reason for China to acquiesce to this demand. In the next decade, China will need to find employment for something like 14-15 million people per year. That requires an average annual GDP growth rate of something between 7% and 8%. Achieving this target depends upon China continuing to grow its exports and attracting investments. I don’t see China harming its export growth by suddenly letting the yuan float after decades of having a fixed exchange rate. The argument gets stronger still because of the 2008 Beijing Olympics. China wants this event to showcase its impressive economic achievements to the world. It will not destabilise anything — and certainly not its tried and tested fixed exchange rate system — to accommodate the “requests” of the US Treasury Secretary.


China needs growth. It doesn’t have a huge overall trade surplus, unlike Japan in the early 1980s, or even today. It has a weak banking system. Why should it jeopardise all this by administering a shock therapy to its currency?


At most, China may experiment with some extremely limited exchange rate flexibility. It might, for instance, create a narrow plus-minus 2.5% intervention band, and then the let the yuan wriggle within it like a “snake in the tunnel”. More than that seems unlikely — at least for the next year or so.


Frankly speaking, the US really cannot justify its attempts at ‘persuading’ China to float the yuan. Contrary to US public opinion, the $490 billion trade deficit of Uncle Sam is not on account of China alone, just as it was not only due to Japan in the early 1980s. China accounts for roughly a fifth of the US trade deficit, or about $100 billion. While it is large in absolute terms, it can’t be China’s fault that the US has a long standing pathology of importing much more than it exports. Research shows that the US has an import elasticity of 1.8, versus an export elasticity of 0.8% — for every 1% rise in overall spending, the US tends to increase its imports by 1.8%, whereas for a 1% rise in foreign demand, US exports increase by only 0.8%. So, blaming the “undervalued” yuan may make for good rhetoric, but it doesn’t stand up to empirical scrutiny.


The reason why US is making these noises has much more to do with politics than economics. While there is an economic recovery under way, every indicator shows that US manufacturing is continuing to hurt, and that the maximum unemployment is concentrated in that sector. Given that America is now gearing in for the 2004 elections, it is hardly surprising that someone has to be blamed for joblessness. Two decades ago it was a demon called Japan. Now it is China.


Instead of asking China to reflate its currency, the United States should be happy that Asia has an unbounded appetite for US Treasury Bills. The US current account deficit is now set to cross 5% of its GDP. The fact that the dollar devaluation is under control has much to do with Tokyo, Shanghai, Bangkok, Hong Kong and Beijing holding T-Bills.


No doubt, if the yuan were to appreciate, India would have a more competitive edge. But the yuan isn’t getting there in a hurry. So let’s stop counting chickens, and get down to squeezing more costs out of our operations.


Published The Economic Times, October 2003


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