The US and Europe have recently joined the call from Japan demanding China to revalue the renminbi (RMB). There is also a belief that RMB revaluation would pull Hong Kong out of its economic doldrums. Meanwhile, China's central bank is sounding an alarm on inflation threat stemming from a robust economy and property punting, making RMB revaluation a sensible policy to curb inflation.
Think again. It might not deliver the hoped benefits, but could instead add to the global economic risk at the time when the world economies are struggling to climb out of a synchronized slowdown. China is unlikely to give in, while international pressure will not ease soon. This standoff will have positive implications for China's liquidity environment, reform process and the RMB forwards market.
The hypocrisy behind the revaluation call
With an uncertain economy and a nine-year high unemployment rate, American anxiety about China's export power has become a big political issue in the run up to the presidential election next year. Some lobbyists in Washington are accusing Beijing of disrupting the market and snatching American jobs by manipulating the RMB, though the US is pursing her own currency intervention.
It is hard to imagine how the US, with a different and more advanced economic structure, would compete head-to-head with China and get badly hurt as those critics have claimed. An RMB revaluation might help preserve temporarily those minor US industries that do not have the comparative advantage in making low-level goods that China is good at. But it would also hurt those efficient US firms that have outsourced to and export from China.
Japan's voice about a cheap RMB stealing its lunch is arguably a ploy of using the RMB as a scapegoat to divert attention from its structural reform failure. Japan has been relying on export growth to sustain her sick economy without making enough reform commitment. Like the US, Japan imports from China mostly labour-intensive low-level consumer goods that it does not have a comparative advantage anymore, and operates factories in China to make many of the Chinese exports.
Europe, which also suffers from reform inertia, is also prone to use China as a scapegoat. It is unfortunate that there are powerful economies following Japan's self-deceiving view because the scapegoat strategy may encourage protectionism, demonise China as a global economic threat, and eventually destroy the gains from trade that the global system has strived for.
Revaluation may not help
Thus, the RMB revaluation benefits do not add up. It would force Europe, Japan and the US consumers to pay more and hurt their corporate profits by hurting their Chinese-made exports. Their economies stand to lose more than the gains by their sunset industries.
Arguably, it is a misperception that a higher RMB exchange rate would make foreign goods cheaper in China and Chinese goods dearer overseas. This is because most of the inputs that make China a manufacturing powerhouse are not priced in RMB, but in US dollars. In many cases, the RMB components in the Chinese manufactured goods account for less than 10% of the final retail price when they are sold in the US. Many Chinese manufacturers think almost exclusively in US dollar terms for their financing needs, payments for raw materials, parts and production services, and pricing of their products.
The hope that revaluing the RMB could help Hong Kong is also illusive. While a dearer RMB may boost Hong Kong exports to China, this is not the whole story. A lot of Hong Kong exports to China are processed in the Pear River Delta (PRD) region for re-export to third markets. The import content of PRD exports is estimate at 70% to 80%. The derived demand for Hong Kong goods by China would fall if revaluation hurts Chinese exports to the world market.
Contrary to the conventional wisdom, revaluing the RMB may actually hurt everyone. While China's share of the global export market has risen, so has her import growth. China has been running a trade deficit with Asia since 2000. Her global trade surplus has fallen 83% since 1998, and is still dropping.
China's soaring imports and falling trade surplus have much to do with her RMB policy. Fixing the RMB in the face of large capital inflow is a powerful stimulant for domestic demand, as the authorities have to raise money supply to keep the exchange rate from rising. This has triggered a spending and import boom. China's current account has been falling as a result.
An RMB revaluation could also cut China's current account surplus, and so please the critics. But it would do so by crimping China's growth, reducing her imports and doing no good to everyone.
How does China's inflation scare fit in all this?
Current inflation is a phantom threat in China. Overall inflation is running at less than 0.5% a year, with prices still falling in many industrial sectors. The massive liquidity that the central bank has injected into the system as a result of RMB peg policy has been partially sterilised. The PBoC has been issuing an average of RMB130 billion (US$15.7 billion) bonds in each quarter since last autumn to mop up the liquidity and cutting reserve money growth to 5% from an average of 13% in the past 2 years. The pockets of property market bubble in Shanghai and Beijing will not ignite inflation, since the wealth effect from the asset market on consumption is tiny in China. Finally, red hot economic growth is expected to ease off.
Beijing may be trying to manage international expectations on its exchange rate policy by playing up the inflation scare. If the global economy stabilises later this year, the pressure on China to revalue will fade. Thus, it could be a tactic of China to buy time. The RMB will eventually float, but not because of outside pressure.
Risks
From China's perspective, changing the currency regime could bring instability, which is not desirable at this time when the new leadership is still consolidating its political base. More crucially, revaluation will not stick. If a dearer RMB hurts Chinese exports, the domestic sector will fall back into deflation, pulling down the real RMB exchange rate.
A weakening Chinese economy under the current weak global backdrop is undesirable. If China won kudos by being an island in the storm during the Asian crisis, when its robust growth allowed it not to join competitive devaluation, no one should appreciate a failing Chinese economy being pushed by RMB revaluation when the global economy is in much weaker today than 6 years ago.
More subtly, the rise of China's economic clout is an external force pushing the world economy to retrench along the lines of comparative advantage. The restructuring is an optimisation process that will create wealth for the global system in the longer-term. It will be a pity if the major economies opt for a weak currency policy, by forcing China to revalue, as an escape route to eschew tough but needed economic reforms.
Implications
International pressure on China to revalue will not abate in the short-term. But China is not likely to comply. This standoff will translate into more upward pressure on the RMB forwards.
With an under-developed capital market, China will not be able to fully sterilise the impact of large capital inflows and rising foreign exchange reserves. Thus, liquidity will remain benign for China's asset market and economy.
Ample liquidity resulted from the RMB peg will allow Beijing to speed up financial reforms. The authorities should accelerate bank recapitalisation by selling more long-term bonds to the banks to improve their asset quality and help them cut bad debts.
Chi Lo, author of the new book "When Asia Meets China in the New Millennium", Pearson Prentice Hall, 2003, ISBN 0131028421.
