Why China resists foreign demands to revalue its currency? An interesting point which I am sure must be waving around in everybody’s mind. There is an article published recently in ‘The Economist’ which I am posting below. Lot of arguments and counter arguments on the issue are covered in the article. But after reading the article, I am in a fix to decide what or who is RIGHT….I want you to post your comments after reading it. Enjoy reading.PRESIDENT Barack Obama, on his first visit to China, urged the government to allow its currency to rise. President Hu Jintao politely chose to ignore him. In recent weeks Jean-Claude Trichet, the president of the European Central Bank, and Dominique Strauss-Kahn, the managing director of the International Monetary Fund, have also called for a stronger yuan. But China will adjust its currency only when it sees fit, not in response to foreign pressure.
China allowed the yuan to rise by 21% against the dollar in the three years to July 2008, but since then it has more or less kept the rate fixed. As a result, the yuan’s trade-weighted value has been dragged down this year by the sickly dollar, while many other currencies have soared. Since March the Brazilian real and the South Korean won have gained 42% and 36% respectively against the yuan, seriously eroding those countries’ competitiveness.
Speculation about a change in China’s currency policy increased in the week before Mr Obama’s visit, after the People’s Bank of China tweaked the usual wording in its quarterly monetary-policy report. It dropped a phrase about keeping the yuan “basically stable” and added that foreign-exchange policy will take into account “international capital flows and changes in major currencies”. But exchange-rate policy is decided by the State Council, not the central bank. And many policymakers, notably in the Ministry of Commerce, do not favour a revaluation right now.
Indeed, Chinese officials have become bolder in standing up to Washington. “We don’t think that it’s good for the world economic recovery, and it is also unfair, that you ask others to appreciate while you depreciate your own currency,” said a spokesman for the Ministry of Commerce on November 16th. The previous day Liu Mingkang, China’s chief banking regulator, blasted Washington for its low interest rates and for the falling dollar, which, he claimed, was encouraging a dollar carry trade and global asset-price bubbles. He strangely ignored the fact that China’s own overly lax monetary policy, partly the result of its fixed exchange rate, is fuelling bubbles in shares and property.
Foreigners argue that a stronger yuan would not only help reduce global imbalances, such as America’s trade deficit, but would also benefit China. It would help China regain control of its monetary policy. By pegging to the dollar, it is, in effect, importing America’s monetary policy, which is too loose for China’s fast growing economy. A stronger yuan would also help rebalance China’s economy, making it less dependent on exports, putting future growth on a more sustainable path.
If a stronger exchange rate is in China’s own interest, why does it resist? Beijing rejects the accusation that its exchange-rate policy has given it an unfair advantage. It is true that other emerging-market currencies have risen sharply this year, but this ignores the full picture. Last year China held its currency steady against the dollar throughout the global financial crisis, while others tumbled. Since the start of 2008, the yuan has actually risen against every currency except the yen.
Beijing also argues that it has done a lot to help global rebalancing. Thanks to its monetary and fiscal stimulus, domestic demand has contributed an incredible 12 percentage points to GDP growth this year, while net exports subtracted almost four percentage points. Its current-account surplus has almost halved to around 6% of GDP from 11% in 2007. Chinese policymakers accept that the yuan needs to appreciate over the longer term, but say now is the wrong time, because exports are still falling, by 14% over the past 12 months.
Another reason for hesitation is that the theory that revaluing the yuan will allow Beijing to tighten its monetary policy is too simplistic. China’s experience since 2005 shows that a gradual rise encourages investors to bet on further appreciation; hot-money inflows then swell domestic liquidity. A large one-off increase might work, as it would stem expectations of a further rise. But the sort of increase required—perhaps 25%—is politically unacceptable because it would put many exporters out of business overnight.
Some Chinese economists warn that the benefits to America from yuan revaluation are much exaggerated. In particular, a stronger yuan would not significantly reduce America’s trade deficit. There is little overlap between American and Chinese production, so American goods cannot replace Chinese imports. Instead, consumers would simply end up paying more for imports either from China or other producers, such as Vietnam. This would be like imposing a tax on American consumers.
These arguments help explain why China is dragging its feet. Nevertheless, in the long run, a stronger yuan would benefit China’s economy—and the world’s—by helping shift growth from investment and exports towards consumption. It would boost consumers’ purchasing power and squeeze corporate profits, which have accounted for most of the increase in China’s excessive domestic saving in recent years. China will probably allow the yuan to start rising again early next year. This will not be the result of foreign lobbying—indeed, China is more likely to change its policy if foreign policymakers shut up. But by early next year China’s exports should be growing again, its year-on-year GDP growth could be close to 10%, and its inflation rate will have turned positive. The arguments in favour of revaluation will then loom much larger.
