In an unusual move, ambassadors to China were called in by Chinese Foreign Ministry on Saturday, the 20 June 2010 at 6 PM to be informed that China will increase the flexibility of its exchange-rate system. This was welcomed warmly by all those, particularly the US and other Western countries who have fiercely been advocating for de-freezing Yuan, labeling China as a currency manipulator that suppresses value of its Yuan for unfair trade advantages. The US has repeatedly threatened China to treat Chinas currency policy as a subsidy warranting US duties on more Chinese imports.
True, there was tremendous pressure on China from the US and other countries; it is also a fact that Chinese Ministry of Commerce has been a long standing opponent of any move which renders Yuan stronger. The Ministry has consistently maintained that scrapping of Yuans peg to the dollar would only spell bankruptcy for many export-oriented manufacturing working on thin margins. This was, however, countered by Vice Commerce Minister Jiang Yaoping who said that the impact of the exchange rate was secondary to a host of other factors, including final demand, wages, the cost of raw materials, the level of interest rates and tax rates.
It is not that the decision of unshackling Yuan from dollar has come abruptly. It is understood that Peoples Bank of China had held serious discussions on the flexibility of exchange rate of Yuan as early as December last year, when the Central bank wanted more autonomy on monetary policy, but the decision could not be taken due to strong opposition from pro-export lobbies. Another reason for not taking a decision in favour of freer Yuan was that a shift in Chinas stand of keeping Yuan pegged could expose Chinese leadership to criticism by nationalists alleging that China has acted under external duress, reflecting a perceived loss of face that could be compounded if they were then to let the Yuan rise at a rapid rate.
However, politically, the decision was indeed too important, and as it is understood, it was taken by the countrys highest decision making body, the nine-member Standing Committee of ruling Community Partys Politburo. Letting the Yuan rise could also help cool anti-China sentiment in the US Congress and fend off the risk of China being declared as a currency manipulator by the US Treasury.
There were, however, strong economic reasons too. It was felt that a stronger currency is Chinas interest because it will add momentum to domestic demand which was in keeping up with the Chinese Government strategy to spread wealth, reducing yawning income inequalities and reducing heavy reliance on investment-rich export industries. A firmer Yuan could also help capping inflationary pressures. Montek Singh Ahluwalia, Deputy Chairman, Planning Commission said, "Moving from a rigid peg to what looks like a mere flexible arrangement is a serious move and I think they should be complimented for it.." He added, "Il think they are probably signaling that they will do something similar to what we have been doing. That is quite sensible, I think. And I think they are also right that they are not going to free it completely. We have not freed it completely, too."
Slow Appreciation of Yuan Likely
How fast will Yuan appreciate? It is a billion dollar question. To my mind, the appreciation of Yuan is going to be slow and gradual. In its statement, the Peoples Bank of China stated that its external surpluses have been falling. As such, the basis for large-scale appreciation of Yuan exchange rate does not exist. Further, the debt woes of the Euro zone, Chinas biggest trading partner, only reinforced this view. According to knowledgeable sources, PBOC will initially be cautious about taking advantage of the permission it has been given to revert to the flexibility it enjoyed before the Yuan was effective re-pegged near 6.83 per dollar in mid-2008 to provide stability during the global economic crisis.
In fact, if one were to refer to the previous experience, it would be seen that during the three years following an initial 2.1 per cent revaluation of the Yuan on July 21, 2005, Yuan gained a further 19 per cent, but during 2005, the appreciation was just 0.56 per cent. According to a recent poll conducted by Reuters, a median forecast of 33 economists was that the Yuan will end 2010 at 6.67 per dollar, which works out to a rise of 2.4 per cent from the level existing on June 20, 2010. It will be pertinent to recall that in the past, the Yuan rarely fluctuated more than 0.1 per cent in intraday trading, even though the trading band permitted a rise of 0.5 per cent against the dollar each day. According to the survey, Yuan will appreciate against US dollar by 3.8 per cent over the next year.
The Peoples Bank of China in its statement said, "With the balance of payments account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist. However, by mid-afternoon, the Yuan had gained 0.35 per cent from its opening level as the PBOC allowed traders to drive the currency higher, but such a rapid rate of climb will not last long, according to Reuters poll. According to Qian Wang and Grace Ng, economists at J.P. Morgan said, "The pace of RMB/USD appreciation will likely be accelerated as the Chinese Government gains more confidence in the resilience of the global economic recovery and a soft-landing of the domestic economy. We continue to expect RMB/USD to reach 6.6 by the end of this year."
Calibrated Appreciation of Yuan will Annoy US
It is, however, certain that Chinese signal to ease its currencys 23-month old peg to the dollar will not satisfy US lawmakers, unless it opens the door to significant upward movement in the Yuan. US President Obama could still charge China as a currency manipulator. On the other hand, PBOC said it would gradually make the Yuans exchange rate more flexible, in a possible return to policies it pursued from 2005 o 2008, but Beijing has ruled out a one-off revaluation or major appreciation sought by critics.
I presume that the US would like to wait for sometime to see how Beijing responds to any Yuan rise in financial markets. Says C. Fred Bergsten, Head of Peterson Institute for International Economics, "If they let the rate start going up on a one-shot basis, that is significant, or look like letting it go up consistently by say a per cent or so a month. Either of those should be enough for the Treasury or the Congress to say, "OK", this is now moving in the right direction. But if this just a statement of principle and nothing much happens for a couple of weeks or couple of months, then you have to resume the pressure." This was re-affirmed by Sander Levin, Chairman of the House of Representatives Ways and Means committee when he said, "Congress would not be mollified if China only tinkered with its exchange rate. We have seen actions like this before and it is clear that China did not allow enough appreciation the last time it adopted a policy like this one, from 2005 to 2008."
Raghuram Rajan, Economic Professor at the University of Chicago and former Chief Economist at he International Monetary Fund said Beijings announcement "will allow both China and the US to cool off before either side does something to precipitate a trade war. "However, one can be sure that US politicians would not want to be seen as weak on China before the Congressional elections in November this year. Even if Washington gives China a pass in the delayed currency manipulation report, now expected by early July, the next semi-annual report is due on Oct. 15, just weeks before the election day.
Persisting doubts on Chinese action
US President Barack Obama said in Washington that China had made progress by announcing greater currency flexibility but it was too early to tell if the Yuans rise would be enough to help rebalance world growth. "We did not expect a complete 20% appreciation overnight, for example, simply because that would be extremely disruptive to the world economy" he said.
The observers feel that China needs to allow the Yuan to rise, even if it is in tiny steps, to prove that it is serious in its commitment to make the currency more flexible. US Treasury Secretary Timonthy Geithner stressed that Beijings actions would speak louder than words. Under this scenario, the Central bank could use its setting of the Yuans daily reference rate to nudge the exchange rate up by modest amounts each day for a few months until the global economic pictures emerges clearer. Andy Rothman, a strategist in Shanghai said he expected appreciation of about only 0.2 per cent a month until Europe stabilizes and thereafter one can expect the appreciation to return to the 5-7 per cent pace of the 2005-2007 period. He also said China was likely to focus almost exclusively on the Yuan exchange rate against the dollar, despite lip service to managing the exchange rate with reference to a basket of currencies.
How much will Yuan Appreciate ?
Many Western economists have estimated that Yuan is still under-valued by 25 per cent to 40 per cent, giving Chinese companies a huge price advantage in international trade. A US manufacturing group that blames Chinas currency for the loss of more than a million jobs said its members still want Congress to keep up the pressure on China. "Unless the move is rapid and significant, Chinas announcement is nothing than a cynical ploy, ahead of the G-20 and in the wake of mounting Congressional pressure, said Scott Paul, Executive Director the Alliance for American Manufacturing. This negates the prediction of some of Indian garment exporters, who hope that Chinese Yuan can appreciate 10 per cent within a week, making their exports more expensive by 5-6 per cent.
Impact of Yuan Appreciation on India...
Senior Indian economic officials have welcomed Chinas recent move on the Yuan. Leading the pack, the Finance Minister, Pranab Mukherjee said Chinas decision to make it currency Yuan flexible would not hit the Indian economy adversely. However, according to Subir Gokarn, Deputy Governor, Reserve Bank of India, it was too early to judge the impact that Chinas pledge to let the Yuan appreciate would make on the Rupee and on other variables, adding, however, that a sense of reassurance had set in post the Yuan pledge and there was no need to worry about the short term volatility of the Rupee. He says, that clearly there is a strong signal from China on its change of stance...and for the global financial community a sense of some reassurance has come that this imbalance issue, at last some resolution, is starting to be seen. RVS Sridhar, President and Head-Markets (Treasury) at Axis Bank observed that India would get benefit in terms of export competitiveness. If China appreciates its currency, the cost of exports will increase, which is expected to give some sort of advantage to Indian exporters.
...And Garment Exports
India and China have traditionally been competitors in textiles and garment exports, with China leading not only India, but almost the entire world in offering textiles and garments at most competitive prices, backed by a number of strong favourable reasons including and particularly the total State support not only in terms of repeated upward revision of subsidies from time to time, but also by strongly pegging the Yuan with US dollar. With the likely appreciation of Yuan, Indian products including garments would become more competitive in the international market. This is the near unanimous opinion of Indian textile and garment industry.
Says Director General, Confederation of Indian Industry (CII), "Indian exporters will be able to give competition to their Chinese rivals in the global market, if Yuan appreciates in sync with the strength of Chinas economy. Indian exports of textiles, gems and jewellery, handicrafts and leather, which directly compete with Chinese consignments in the Western markets, will gain. We expect our exporters to benefit from such a move (Yuan appreciation).
"The announcement is definitely in the positive direction and if it is backed up by action, it will benefit India quite substantially, as its exports will become more competitive. But one has to see to what extent they back their announcement with action", says D.K. Nair, Secretary General of the Confederaion of Indian Textile Industry (CITI). Adds Premal Udani, Chairman of Apparel Export Promotion Council (AEPC), "We are very happy that they (China) have decided to float their currency and it will provide us with a more level playing field. We hope it is a long-term thing and will help us in the long run. They are still better than us in productivity and pricing, but in the long run it will benefit us."
"Today, the pricing difference is not that great and some big players are actually very competent. The real problem is the lack of production capacities in India. That is the only caveat and we might not b able to realize the potential of such an advantage." Says Prashant Agarwal, Vice President of Consultancy firm, Technopak. "We will have to adopt wait-and-watch strategy. In any kind of appreciation, there is a limit to which the buyer can absorb and it can only be clear later how much the buyer can absorb in this case. But given that we will be more competitive, more buyers will look at India" says Praveen Nayyar, Managing Director of Delhi-based Dimple Creations.
In conclusion, the unshackling of Yuan has indeed been an important event , which has made everybody sit up and preview its impact in the areas of his interest. There has been a lurking doubt in the minds of both Indian and the Western observers that China may not let Yuan to appreciate either very fast or very high and there are several reasons to assume that gradualism will be the initial watchword. However, the fact remains that US would continue to be in hot pursuit of China to securess more flexibility to Yuan exchange rate for their own domestic and political circumstances on account of November elections, which are not very far away. This, to my mind, could be somewhat reassuring for a reasonable level of appreciation of Yuan, which could benefit Indian garment exporters, conditioned further by their capacity to produce enough garments to meet the likely more demand from international market. (2434)