China’s RMB Revaluation: Not Now and Not Soon

January 10 2003 (FriedlNet.com) - China’s nearly $200 billion trade-dominated current account surplus along with the mass accumulation of more than $300 billion in foreign direct investment that have beefed up foreign reserves to stratospheric levels have induced many a whiny plea from Japan and other countries abroad with respect to the Middle Kingdom’s current restrictive capital account regime. Content with the status quo of cheap exports and deep pockets of reserves, senior Chinese officials are not to be convinced to delve off into currency floating debauchery anytime soon, with Premier Zhu Rongji last week hinting at the general mood by noting that “to stick to the policy is in the interests of our country.”

The Chinese currency RMB has been pegged to the US dollar since 1994, held within the narrow band of 8.276-8.28 RMB to the dollar via Chinese central bank intervention. In the nearly 10 years of “managed floating”, the currency has only appreciated a rough 5%. Praised by the international community, China kept its currency peg during the Asian financial crisis in 1997-98, thus avoiding further regional destabilization. Mainland authorities are certain to have kept a close eye on the demise of the Paper Tigers, whose currencies crashed into oblivion after their flimsy capital accounts - brought on by the era of free floating enthusiasm – were sucked dry by international investors gone helter-skelter amidst bubble fears. Wary not to succumb to the same virus of investor corto-plazismo, Chinese authorities have made stability the dominating principle in their code of conduct.

With this in mind, China is understandably very unlikely to let a rash currency revaluation ripple through the country. Before any changes are made, Chinese authorities have made it very clear that setting up a sound financial framework is of utmost importance. “I agree with globalization and I am strongly in favor of liberalization. But it most be done in sequence. It can be very risky to open the door too wide,” the Financial Times quoted Liu Mingkang, the head of the state-owned Bank of China and former deputy governer of the central bank, as saying. The door will open, the question is just when. Last year’s governor of the People’s Bank of China – Dai Xianglong – mentioned on numerous occasions that full RMB convertibility remains China’s long term goal.

Now China’s central bank has a new boss, Zhou Xiaochuan – the former head of the State Administration on Foreign Exchange but this won’t speed up any revaluation considerations. Michael Kurtz, an analyst with Bear Stearn Asia Ltd., said this Tuesday that “recent Beijing personnel changes and a pressing structural reform agenda suggest a material revaluation will not be forthcoming in the next 24 months,” Dow Jones reported. Last November, the Chinese foreign trade minister Shi Guangsheng dropped a bombshell on revaluation hopes when he noted that “we have not considered the possibility of a revaluation,” says the Financial Times.

In the short term, many mainlanders – especially those engaged in the export business – are very happy with the current constellation. The cheap RMB keeps exports dirt-cheap. The low export prices, tugged even lower by low domestic wage costs, are flooding foreign markets where indigenous products simply cannot compete in price with their Chinese rivals, giving the Middle Kingdom a sharp weapon in the international trade war. It then comes as no surprise that last Sunday Chinese Premier Zhu Rongji ruled out a currency revaluation when he noted, with respect to the current peg, that “it has effectively safeguarded the country’s economic growth and financial stability,” as reported by the official Xinhua news agency. A revaluation that leads to a strengthening of the currency would only blast away the precious competitive trade advantage. Not only that, with imports tariffs falling in line with WTO, a currency strengthening would only add on to the already huge competitive pressure on domestic producers.

Symptomatic of international trade asymmetries, the United States’ trade deficit with China had widened to $83.1 billion in the January to October period of 2002, up from the year-on-year figure of $70.4 billion. Premier Zhu also reported the central bank’s reserves of foreign currency to have grown 35% in 2002 to $286.4 billion.

Most outsiders believe the current Chinese currency valuation level to be too low, and are quite unhappy about it. As reported by Bloomberg, a recent report by Goldman Sachs estimated that given China’s growing economic strength, the RMB currency is undervalued by about 15%. This may feed the Chinese export sector, but at the expense of other countries’ competitiveness. At the same time, the under-valuation induces a misallocation of capital, as investment decisions are not based on the relevant market prices, but rather clouded by currency prices that are set by policy regulation rather than market forces. The International Monetary Fund has in the past repeatedly used this argument to try and persuade China to adopt a more flexible exchange rate regime, lest economic distortions and capital misallocations infest the system.

The Bush administration earlier this week commented on the situation via the U.S. Treasury’s undersecretary for international affairs, John Taylor: “As there is more foreign investment, direct investment and more trade, there will be more reasons to move toward a greater flexibility to prevent other imbalances than can occur.” Taylor noted that the best constellation for large economies to achieve long periods of stable growth is that of low inflation, low interest rates and a free-floating currency.

Especially whiny have been the Japanese - the country’s vice-finance minister for international affairs, Haruhiko Kuroda, last year complained that China’s falling prices and fixed exchange rate were putting pressure on countries making competing products.
On the assumption that the RMB would appreciate upon floating – reinforced by a hefty trade surplus and mountains of foreign direct investment – Japan is hoping that China relaxes its grip as soon as possible.

On the currency policy issue, China is stuck between a rock and a hard spot – for whichever way it moves, or doesn’t move – the country is up against criticism. But for the time being, the country is playing it safe. And in case anybody has noticed, China has actually already made respectable moves towards relaxing the currency regime: the QFII scheme, which went into effect last December, is loosening up portfolio flows (see article "China Opens A-Share Market to Foreigners"). A safe step instead of a sorry one – Chinese capital account liberalization is coming in gray tones rather than a big white bang.

Something to say? Click here to send a letter to the China Business Monitor.

Home | Terms and Conditions of Use | Privacy Policy