Sunday, November 22, 2009

Why China is Hesitating to Revalue Its Currency


Economist: A-yuan-sided argument

Financial Times: Renminbi sparks strong views; Beijing signals send renminbi higher

IMF: The International Monetary System: Reforms to Enhance Stability and Governance

Despite the growing international pressure for a stronger renminbi, China will revalue its currency “only when it sees fit,” not owing to the international pressure, according to the Economist. China allowed the renminbi to rise by almost 20% against the dollar between July 2005 and June 2008. In July 2008, however, it pegged the renminbi again to the dollar in order to protect its exporters during the global financial crisis. Many, including Dominique Strauss-Khan, the managing director of the IMF, have urged China to allow its currency to rise, arguing that a stronger renminbi would reduce global imbalances as well as help rebalance China’s own economy.

There has been speculation about whether China would revalue its currency during President Obama’s first visit to China. Notably, a week before his visit, the People’s Bank of China changed the usual wording of a key currency policy statement. In its quarterly monetary policy report, the central bank did not use a phrase about its intention to keep the renminbi “basically stable,” and added that it would take into account “international capital flows and changes in major currencies.” However, there was no revaluation of the renminbi during Mr. Obama’s visit.

China has its own arguments for delaying revaluation of the renminbi. First, China simply rejects the accusation that fixing the renminbi to the falling dollar gives an unfair trade advantage to its exporters. Second, China emphasizes that it has already done a lot to reduce global imbalances as its monetary and fiscal stimulus boosted domestic consumption. Net exports declined almost about 4 percentage points, and its current-account surplus has almost halved to about 6% of GDP from 11% in 2007. Third, a large one-off revaluation of the renminbi (perhaps 25%) would be politically implausible as it would make its exporters suffer greatly. Lastly, some Chinese economists argue that a stronger renminbi would not significantly help the US reduce its trade deficit. Since there is little overlap between American and Chinese production, American goods would unlikely replace Chinese imports. As a result, American consumers would have to pay more for imports from China or other countries.

These arguments may work for now. However, the arguments for revaluation will be much more persuasive by early next year when China’s exports grow again, its GDP grows up to 10%, and its inflation rate turns positive. The Economist pointed out that China is unlikely to change its exchange policy because of the international push. Rather, China will more likely change it if foreign policymakers would “shut up.”

Discussion Questions:

1. “China is loath to give in to foreign pressure,” says Michael Hart at Citigroup. Do you agree with his statement? If the statement is true, should other countries and multilateral financial institutions stop urging China to revalue its currency? Do you think China would not revalue its currency even when it sees revaluation is in the best interest for China simply because China does not want to give in to foreign pressure?

2. Do you agree with the argument that there is little overlap between American and Chinese products and revaluation of the renminbi would only make American consumers worse off?

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