After weeks of international pressure, the People's Bank of China, China's central bank, announced over the weekend that it will increase the flexibility of its exchange rate, fuelling expectations that it will gradually let the renminbi appreciate. The move comes after the renminbi has been effectively pegged at around 6.83 per dollar for almost two years.
The bank's rationale for the policy change is that: "The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the renminbi exchange rate regime and increase the renminbi exchange rate flexibility." (For a full translation of the statement, click here.)
While China is not known for bowing to international pressure directly, the announcement was neatly timed just a week before leaders of the 20 biggest developed and developing economies meet on June 26-27 in Toronto, Canada, for the G20 summit. So it was clearly politically driven.
So what should you expect? As the central bank says in a statement, "... the basis for large-scale appreciation of the renminbi exchange rate does not exist". So don't expect an overnight change.
Chinese officials said the renminbi will move in relation to a basket of currencies, not just the dollar. While we know the past is no indication of the future, it's sometimes a guide. So let's look at the last time the central bank moved away from the dollar peg. Between July 2005 (when the PBOC first introduced a managed floating exchange rate regime based on a basket) and July 2008 (when the recent peg was put in place), the renminbi appreciated 21%. That's 7% a year. While one shouldn't wager on a repeat of the same exact percentage increase, it's certainly a reference for the bank's view of gradual.
In a research note released by Goldman Sachs yesterday, the bank said: "In our view, the appreciation will likely take place through downward movements in central parity rates as well as during intra-day trading."
Goldman Sachs economists said the bank will keep its three-, six- and 12-month USD/CNY exchange rate forecasts unchanged at 6.74, 6.66 and 6.49. "In addition, the likely absence of a sizeable one-off change in the spot exchange rate is consistent with our expectations that Chinese government officials prefer to use a risk-based gradualist approach in policy reforms," they noted.
What does this mean for China? For sure, some low-end, low-margin, local manufacturers exporting to the US will blame any currency move for any failure they may have in the next few months. But Jun Ma, chief economist for Greater China at Deutsche Bank Hong Kong, wrote on the day of the announcement that the reform "will also be part of the structural changes to reduce the reliance of economic growth on exports and facilitate the transition to a consumption-driven economy".
And what does it mean for the rest of the world? Provided that the appreciation is steady and forthcoming, it may help stave off a trade war with the US -- the lower-valued currency made imports from China cheaper and US exports more expensive, which was excellent fodder for US Congressmen to whine about rather than dealing with home-grown problems. But it does mean that China can be relied less upon when it comes to purchasing US Treasury bonds as a way to manage its renminbi peg to the dollar. It will now have greater flexibility and therefore it won't need to buy as many securities in the future. So it's a move that should help even out some of the global economic imbalances.
That said, it took a long time, with quite a bit of intense posturing from China, the US and the European Union before this weekend's announcement of further reform. If no real changes follow, the political fallout could be quite intense. Timothy Geithner, the US secretary of the Treasury, has been one of the more vocal advocates pressuring China to move its currency. His statement after the PBoC announced its new policy was therefore cautious. As he summed it up: "This is an important step, but the test will be how far and how fast they let the currency appreciate."
What would be ideal is if both the US and China learn to trust one another and channel information more clearly. Rather than having the US bully China with a megaphone and grand speeches and China digging its heels in, crossing its arms and saying "we won't be lectured to", it would be better if politicians could handle the issue more diplomatically.
