Upload
maxdcosta
View
2
Download
0
Embed Size (px)
DESCRIPTION
article
Citation preview
Why yuan cannot replace dollar for int'l tradeLast updated on: November 1, 2012 10:58 IST
Abheek Barua, chief economist
at HDFC Bank, explains why
China's renminbi is a long way
from becoming a global reserve
currency.
There is a common assumption
these days that any discussion on
currencies would be dominated by
the future of the euro and the euro zone.
Attending the conference themed "Currencies of Power and the Power of
Currencies", organised by a heavyweight think tank, the International
Institute for Strategic Studies, at its Bahrain office earlier this month, I was
somewhat surprised that China got as much talk time at the conference as
the European currency.
There seemed to be two issues related to China that appeared to bother the
conference participants - a motley mix of politicians, international
bureaucrats, economists, defence analysts and bankers.First, the kind of
strategic power that China's large holding of dollar reserves endows it with.
Second, the consequences of China's bid for rapid "internationalisation" of
its currency, the renminbi.
Let's get to the first issue, which has been debated widely over the last few
years. Is China's dollar reserve holding indeed a serious threat for the US?
Is there a risk of US interest rates skyrocketing if China were to suddenly
sell off a hefty portion of reserves?
The problem with the alarmists' arguments that raise this China bogey is
that they fail to recognise the fact that it is against its interest to shift away
from dollars.
Any effort by China to sell a significant proportion would lead to a sharp
depreciation of the dollar and that would entail a large loss for all dollar
holders including China. Thus, it would be irrational for China to shoot itself
in the foot by shifting its reserves away from the greenback.
Indeed the converse might actually be true - the fact that the US is
a large debtor gives China reason to handle it with caution.
As economist John Williamson argued at the conference, "far more
credible is the fact that the balances (China's dollar reserves) act as
a restraining influence on any Chinese inclination to engage in acts
that would be regarded as hostile to the US. ...As Keynes once
observed, when I owe my bank a thousand dollars, I have reason to
fear my banker; if I owe it a million, he fears me".
There is much less clarity on where the effort to "internationalise"
the renminbi is headed.
China is the biggest trader in the world, with about an 11 per cent
share in global trade. This dominance in trade could give its effort
some traction. But first things first: what exactly does
internationalisation mean? It could simply mean more trade and
investment transactions are billed directly in the yuan (RMB).
Thus, say, an Indian company importing a machine from China
could ask for a price quote in RMB instead of dollars and be able to
execute the transaction by directly exchanging RMB for rupees.
(Currently the company would have to do a three-leg transaction,
buying dollars for rupees and then RMB for dollars).
This would be the most basic internationalisation, and it has
progressed considerably with a number of East Asian economies
using the yuan extensively.
The most extreme form of internalisation would be to make RMB a
major reserve currency that sovereign governments would hold
their surpluses in.
It is not entirely clear that it would be in China's interest for RMB to
emerge as a reserve currency. Reserve currency status effectively entails a
loss of control over the exchange rate, and for a country that has long been
accustomed to managing the exchange rate, this could be somewhat
difficult to accept.
However, for China, many of their economic aspirations stem from the need
to make power statements rather than the balance of costs and benefits.
Significant international holdings of RMB as reserves would be one such
assertion of power.
That said, there could be impediments to internationalisation beyond a
point. To start with, the capital account is controlled and the exchange rate
is managed. Neither of these things is easy to abandon in a hurry.
While it is true that China has made the RMB more flexible over the last
couple of years (it is at a 19-year high currently), it is far from being a free
float. Besides, Chinese policy makers have in the past shown a penchant to
fall back on time-tested policies at the first sign of any serious trouble on
the economic front.
Thus, the possibility of China suddenly reverting to a de facto currency peg
is not negligible, and potential holders of the renminbi have to bear in mind
this risk.
Besides, a robust currency market cannot exist in isolation; it needs the
support of free and flexible financial markets, particularly the money and
bond markets.
China might have undertaken financial sector reform over the past
few years, but much more needs to be done. The question is: does it
really have the incentive to do so?
It is possible to argue that financial sector reforms would help the
process of internal rebalancing that it has embarked on. This
entails a shift away from exports and investments.
Deeper financial markets could encourage households to leverage
their future incomes to finance consumption.
It would also help improve the return on savings, create products
that insure against contingencies and reduce the volume of
"precautionary savings" that households hold to insure against
contingencies. This could raise the share of consumption in the
economy.
But China has another problem. Its first shot at rebalancing the
economy that effectively commenced in the mid-2000s has been
somewhat tardy. The share of investment in national income
continued to rise at least until 2011.
A significant portion of this would involve banks and other lending
agencies lending extensively to unviable "zombie" investment
projects. This would have added to the amount of impaired loans
that are known to be sitting on the books of Chinese lenders.
To prevent an implosion in the financial sector, China needs to
ensure that the savings rate remains high and real interest low.
This creates an incentive to retain the status quo in the financial
sector.
These are some of the contradictions that China needs to resolve on
the path to internationalisation. Unless it does this successfully, the
renminbi is unlikely to emerge as a store of global value.
Know all about China's new currency policyLast updated on: August 31, 2011 11:08 IST
China's government may be about to
let the renminbi-dollar exchange rate
rise more rapidly in the coming months
than it did during the past year.
The exchange rate was actually frozen
during the financial crisis, but has been
allowed to increase since the summer of 2010.
In the past 12 months, the renminbi strengthened by 6 per cent
against the dollar, its reference currency.
A more rapid increase of the renminbi-dollar exchange rate would
shrink China's exports and increase its imports. It would also allow
other Asian countries to let their currencies rise or expand their
exports at the expense of Chinese producers.
That might please China's neighbours, but it would not appeal to
Chinese producers. Why, then, might the Chinese authorities
deliberately allow the renminbi to rise more rapidly?
There are two fundamental reasons
the Chinese government might choose
such a policy: reducing its portfolio
risk and containing domestic inflation.
Consider, first, the authorities'
concern about the risks implied by its
portfolio of foreign securities.
China's existing portfolio of some $1.6 trillion worth of dollar bonds
and other foreign securities exposes it to two distinct risks:
inflation in the United States and Europe, and a rapid devaluation
of the dollar relative to the euro and other currencies.
Inflation in the US or Europe would reduce the purchasing value of
the dollar bonds or euro bonds. The Chinese would still have as
many dollars or euros, but those dollars and euros would buy fewer
goods on the world market.
Even if there were no increase
in inflation rates, a sharp fall in
the dollar's value relative to the
euro and other foreign
currencies would reduce its
purchasing value in buying
European and other products.
The Chinese can reasonably worry about that after seeing the
dollar fall 10 per cent relative to the euro in the past year - and
substantially more against other currencies.
The only way for China to reduce those risks is to reduce the
amount of foreign-currency securities that it owns. But China
cannot reduce the volume of such bonds while it is running a large
current-account surplus.
During the past 12 months, China had a current-account surplus of
nearly $300 billion, which must be added to China's existing
holdings of securities denominated in dollars, euros and other
foreign currencies.
The second reason China's political leaders might favour a
stronger renminbi is to reduce China's own domestic inflation rate.
A stronger renminbi lowers the cost to Chinese consumers and
Chinese firms of imported products as expressed in renminbi.
A barrel of oil might still cost $90, but a 10 per cent increase in the
renminbi-dollar exchange rate reduces the renminbi price by 10 per
cent.
Reducing the cost of imports is significant because China imports a
wide range of consumer goods, equipment and raw materials.
Indeed, China's total annual imports amount to roughly $1.4
trillion, or nearly 40 per cent of gross domestic product (GDP).
A stronger renminbi would also reduce demand pressure more
broadly and more effectively than the current policy of raising
interest rates.
This will be even more important in the future as China carries out
its plan to increase domestic spending, especially spending by
Chinese households.
A principal goal of the recently presented 12th Five-Year Plan is to
increase household incomes and consumer spending at a faster rate
than that of GDP growth.
The combination of faster household-spending growth and the
existing level of exports would cause production bottlenecks and
strain capacity, leading to faster increases in the prices of
domestically produced goods.
Making room for increased consumer spending requires reducing
the level of exports by allowing the currency to appreciate.
Looking back on the past year, the 6 per cent rise in the renminbi-
dollar exchange rate might understate the increase in the relative
cost of Chinese goods to American buyers because of differences in
domestic inflation rates.
Chinese consumer prices rose about 6.5 per cent over the past
year, while US consumer prices rose only about 3.5 per cent.
The three-percentage-point difference implies that the "real"
inflation-adjusted renminbi-dollar exchange rate rose 9 per cent
over the past year (that is, 6 per cent nominal appreciation plus the
3 per cent inflation difference.)
Although this is how governments calculate real exchange-rate
changes, it no doubt overstates the relative change in the prices of
the goods that Americans buy from China, because much of China's
inflation was caused by rising prices for housing, local vegetables
and other non-tradables.
The renminbi prices of the Chinese manufactured products that are
exported to the US may not have increased at all.
The renminbi-dollar exchange rate is, of course, only part of the
story of what drives China's trade competitiveness. While the
renminbi has risen relative to the dollar, the dollar has declined
against other major currencies.
The dollar's 10 per cent decline relative to the euro over the past
12 months implies that the renminbi is actually down by about 4
per cent relative to the euro.
The Swiss franc has increased more than 40 per cent against the
dollar - and therefore more than 30 per cent against the renminbi.
Looking at the full range of countries with which China trades
implies that the overall value of the renminbi probably declined in
the past 12 months.
The dollar is likely to continue falling relative to the euro and other
currencies over the next several years. As a result, the Chinese will
be able to allow the renminbi to rise substantially against the dollar
if they want to raise its overall global value in order to decrease
China's portfolio risk and rein in inflationary pressure.
The author is professor of Economics at Harvard, was chairman of
President Ronald Reagan's Council of Economic Advisers and is
former president of the National Bureau for Economic
Research. Copyright: Project Syndicate, 2011.
Why China keeps its currency undervaluedLast updated on: June 22, 2010 14:04 IST
Equity markets across
the world made
handsome gains after
China announced plans to
make its currency, the
yuan, more flexible
against the dollar. China
on Saturday said it would
allow its currency to
appreciate against the US
dollar.
Market analysts said China's move would go a long way in lifting
the global economic sentiment that has been under the weather
due to the Euro crisis.
In a statement on Saturday, China's central bank said: "In view of
the recent economic situation and financial market developments at
home and abroad, and the balance of payments situation in China,
the People's Bank of China has decided to proceed further with
reform of the RMB exchange rate regime and to enhance the RMB
exchange rate flexibility."
So why is this such a big deal? And why are some economists still
sceptical about the goodness of the Chinese move? But more
importantly why does China deliberately keep its currency
undervalued?
Some economists feel that China's deliberately undervalued
currency costs India billions of dollars annually in growth. Other
world economies, like the United States, are even worse hit.
Currency manipulation is one of the schemes which China has used
to give their exports an unfair advantage. A recent report by the
Economic Policy Institute in the US found that an increasing trade
deficit to China, a decrease in US export capacity to China and
mounting foreign debt have caused $2.4 million jobs to be lost or
displaced.
Beijing uses currency manipulation to maintain the value of its
currency, the yuan, at an artificially low value, which makes its
exports much cheaper and its imports more expensive.
China keeps its currency (yuan) undervalued with respect to the US
dollar by buying dollars in the open market. China, which runs a
huge trade surplus, can afford to buy dollars in the open market to
keep the demand for dollars high, and push the dollar price
upwards relative to the yuan. This keeps the yuan undervalued.
Exports are the Chinese engine of growth. The lower the value of
the yuan, the more advantageous the situation is for Chinese
exporters. So today if one dollar is equal to 7 yuans and a Chinese
exporter sells a shirt for 10 dollars, he gets 70 yuans. However, if
the value of one dollar were to be only 5 yuans (after the yuan is
allowed to reach its real value), the exporter would only get 50
yuans. Thus, to give its exporters an unfair advantage in the world
market, Beijing has lept the yuan undervalued.
China has already flooded various markets -- including the Indian
market -- with cheap goods as its artificially undervalued currency
makes its exporters very cost-competitive. If the value of the yuan
were to appreciate, Chinese goods would no longer be cheap
enough to compete with goods produced locally in these markets
that China invades.
By how much is the yuan undervalued?
Some economists think the yuan is undervalued by 20%. Some say
that the figure ranges from 15% to 40%. However, no one can say
for certain to what extent is the yuan undervalued.
However, when a currency is kept undervalued it leads to inflation
and China has experienced high inflation lately.
Impact of Chinese move on India
Indian exporters like textiles firms and toymakers expect that a
higher yuan can make India's cheaply made goods more attractive
to large markets like the United States and the European Union
and thus boost their business.
The Reserve Bank of India is evaluating the impact on the rupee
and its economy of China's announcement of limited currency
reform. China is one of India's largest trading partners, enjoying a
$15.2-billion trade surplus in April-December 2009.
CII director general Chandrajit Banerjee, in a statement said:
"Beijing's announcement over the weekend to proceed further with
exchange rate reforms and make yuan more flexible is a welcome
news for India and the global economy. However, it remains to be
seen how fast would China allow yuan to appreciate."
The extent to which Indian industry would benefit from the news
would depend on the degree of yuan's appreciation, Banerjee
added.
"Given China's important role in global economy and the world
trade, we welcome the announcement by Chinese authorities. We
expect Indian exporters of textiles, chemicals and light engineering
goods to benefit from such a move," he added. However, Banerjee
stressed that China getting closer to a market-oriented economy is
the best situation.
China's move to allow a more flexible exchange rate for the yuan
could hurt Chinese manufacturers who sell abroad.
The move could also boost purchasing power and consumer
demand in China. A higher yuan will also lead to controlling
inflation in China as import prices will do down.
Some economists sceptical about Chinese move
China's exports surged by 48. 5 per cent year on year in May. This
triggered speculation that the much awaited reform of its currency,
yuan, against the US dollar was round the corner.
In value terms exports totalled $131.76 billion in May, while
imports totalled $112.23 billion. The US and the EU accuse China
of making windfall profits out of its exports by pegging its currency
deliberately low that makes its exports cheaper.
However, Religare Capital Markets Ltd chief economist Jay
Shankar had this to say on China's move and its impact: "China's
decision to make the yuan more flexible this weekend is unlikely to
lead to anything akin to one-off revaluation. The real test will be, as
also noted by the US treasury secretary Timothy Geithner, how far
and how fast the Chinese authorities allow the currency appreciate.
"We believe the let-off will be very gradual and token in nature. The
expected global rally in equity as well as commodity markets,
because of the Chinese actions, is unlikely to last long.
"The Chinese move should be seen as Beijing's attempt at telling
the world that they are as well contributing towards helping
rebalancing the global economy, ahead of the G8 and G20 meet,
scheduled towards the end of this week.
"The Chinese decision will have to be seen with action on the
ground, as to how much appreciation of yuan will be allowed. We
believe that this is a move presented by Beijing as to pacify G8 and
G20 leaders and an attempt to tone down criticisms of Chinese
currency policy likely to be on the agenda of the meets."
But why is China's move on yuan significant? Read on. . .
Business Standard
Why China's move is significant
In the world of economic diplomacy where gestures often mean much more than concrete action, China's move to abandon its currency peg against the dollar is significant. It is, therefore, no coincidence that the move comes roughly a week before the G20 summit in Toronto where pressure on China to adopt a more flexible currency regime was expected to intensify.
China has clearly pre-empted some of this by agreeing to more exchange flexibility. However, this move is unlikely to mean any dramatic change, at least in the near term. While China has committed to dropping its de facto dollar peg (6.83 yuan to the greenback) that it has maintained since mid-2008, it has not promised either a one-off revaluation against the dollar or a free-floating currency. It will continue to "manage" its currency through heavy intervention by its central bank.
Thus, a sharp appreciation in the yuan against the dollar is unlikely. This is incidentally not the first time that China is relaxing its exchange rate regime. It had abandoned its dollar peg in 2005 and moved to a managed float against a basket that included the euro and the yen.
In roughly the three years that this mechanism operated, the yuan appreciated by 21 per cent against the dollar. This might be some indication of how much appreciation is likely in the near to medium term.
Gestures are important to financial markets as well, and the implication of China's move is being analysed threadbare by financial analysts across the world. The immediate response has been to read the move to allow flexibility as proof of the Asian behemoth's confidence in its own economic recovery.
China's stock market has risen, pulling other markets in the region up along with it. Asian currencies, including the rupee, have moved up. Once this initial euphoria abates, there are a couple of issues that markets are likely to grapple with.
But will China puts its money where its mouth is?. . . Read on. . .
China's growth model has been dependent heavily on exports that,
in turn, have fed off an undervalued exchange rate.
Greater exchange rate flexibility could dent exports and the
country's ability to sustain its scorching pace of growth is
contingent on how much the economy has been able to and can
exploit its domestic demand (particularly consumption) base.
If growth shows signs of flagging, financial markets (particularly
those for commodities where China is seen as the key demand
driver) could sell off. It could also resurrect fears of another dip in
growth. Besides, China is the principal creditor to the rest of the
world, particularly the US and Europe where it deploys its one
trillion dollars of foreign exchange reserves in government and
quasi-government bonds.
This stockpile of reserves is the result of its exchange rate policy.
Its central bank has bought dollars and euros relentlessly to cap
the yuan's exchange rate.
A flexible exchange rate regime would reduce the Chinese central
bank's need to intervene in the market and could thus reduce its
stock of foreign exchange reserves, or at least slow down the pace
of accretion. Its appetite for dollar and euro bonds will wane as a
result.
For western governments that are likely to see large budget deficits
and consequently supply large quantities of bonds in the
international markets, this could spell trouble unless the demand
from their own households and companies compensates.
The risk is that interest rates in the G7 countries will tend to rise
sharply. That could keep markets and policy-makers on edge. All in
all, the yuan flexibility story has to play itself out fully before
markets can rush to judgment.
While this weekend's news may win some comfort for Beijing, next
weekend in Toronto the world will wait to see if China puts its
money where its mouth is.