Expect the yuan to feel even more pressure
By Kent Ewing
HONG KONG - Nearly a year after China gave into Western demands to revalue the
country's currency by 2.1%, Chinese leaders now face even more pressure for
further revaluation. And it is not just the China-bashers in Washington who are
leading the charge; the overheating Chinese economy itself points inevitably
toward yuan appreciation. The only questions are: How soon and how much of a
hit is the leadership willing to take?
According to preliminary figures released last week by the state-run Securities
Times, China's economy grew at a torrid 10.9% in the second quarter of this
year. That follows 10.3% year-on-year growth in the first quarter and is well
above Beijing's annual growth target of 8%. Clearly, the much-ballyhooed
macro-controls implemented recently to cool the economy are not working, and
China's central bank must now seriously consider raising interest
rates, which in the short term may prompt additional speculative capital
betting on the yuan, increasing the pressure for further revaluation sooner
rather than later.
In April, the central People's Bank of China hiked the benchmark one-year
lending rate to 5.85%, up 27 basis points, and also raised the deposit reserve
ratio at commercial banks by half a percentage point starting July 5. To stem
excess investment, however, the National Development and Reform Commission
(NDRC), China's chief economic planning agency, has recommended further
concurrent rises in lending and deposit rates by 25 basis points. The yuan
would certainly become firmer on any rate increase.
Increased international pressure for yuan appreciation is certain to follow the
news that China is accumulating monthly trade surpluses unseen in human
history. Chinese customs has reported that the country's exports in June
totaled US$14.5 billion more than its imports, surpassing the previously
record-setting $13 billion month of May. Exports rose 23% year-on-year to $81.3
billion, while imports increased 19% to $66.8 billion.
After it reached a historic high of $102 billion last year, three times the $32
billion imbalance in 2004, economists expect China's trade surplus to climb as
high as $130 billion to $150 billion this year, with a current account surplus
of $200 billion. And in the United States, the trade surplus - $202 billion in
2005 and rising - is worse than the international average.
Bloated figures like these, of course, feed to the gallery of China-bashers in
the US and lead to worldwide demands for further yuan appreciation, which would
make China's exports more expensive for foreign buyers and its imports more
affordable for Chinese consumers.
After his swearing-in ceremony this month, one of the first comments to come
out of the mouth of the new US treasury secretary, Henry M Paulson Jr, was a
call for faster appreciation of the yuan to curb the growing Sino-US trade
imbalance. And there is no shortage of proposals in Congress for sanctions
against Chinese goods. The National Association of Manufacturers is behind one
such proposal to impose duties on Chinese imports.
The indignation in the West is fueled by accounts that the yuan remains
significantly undervalued. Depending on which economist you read, the currency
should rise 10-25% to reach its actual value.
So, a year later, the 2.1% revaluation announced by Beijing last July 21 has
failed to impress. Before that announcement, the yuan had been pegged to the US
dollar for the previous 10 years. Since the revaluation, the yuan has been
measured against a basket of unspecified currencies and allowed to float 0.3%
daily against the greenback - arguably a band so rigid that the Chinese
currency is still, in effect, pegged to the dollar. So far, the yuan has risen
only 1.5 % to stand, as of Friday, at 7.99 to the dollar.
Meanwhile, China's foreign-exchange reserves had soared to $941.1 billion by
the end of June, according to the central bank, an increase of 32.37% over the
same time last year. That means China has overtaken Japan as the holder of the
world's largest foreign-currency reserves (especially dollars); at the same
time, the country has supplanted Britain as the fourth-largest economy in the
world, behind the United States, Japan and Germany.
It is no surprise, then, that calls for another revaluation grow louder. What
are not as well understood, however, are the reasons for Beijing's resistance
to these demands. China's sizzling growth rate may be the envy of the world,
but the country's top economic planners regard their task as a complex
balancing act that could easily be overturned. The NDRC has identified four
main problems that have not yet been adequately addressed: an exceedingly fast
pace of growth in investment, a runaway money supply, unbalanced foreign trade,
and sharp hikes in prices for raw materials.
In its quarterly report, the central bank announced that the country's broadest
gauge of money supply (M2) rose 18.4% in June, down from a 19.1% increase in
May but hardly a strong indication that the problem of excess liquidity is now
in check. And the report also held no assurances that measures to tighten
credit had taken hold, as new local-currency loans totaled 394.7 billion yuan
for June, up from 209.4 billion yuan in May.
While the central government can boast that the lending figure for this June is
more than 20% below last year's rate, it remains high and is, once again,
getting higher. For the first six months of this year, new loans added up to
2.8 trillion yuan, which is 86% of the central bank's projection of 2.5
trillion for the entire year.
With huge US-dollar purchases by the central bank exacerbating the problem of
excess liquidity in an overheated, investment-heavy economy, speculation about
another yuan revaluation is rife, as is the "hot money" flowing into the
country based on such speculation. Chinese officials, however, do their best to
pour cold water on talk of yuan appreciation.
Chinese Minister of Commerce Bo Xilai recently called demands for greater
appreciation "groundless". He denied that the exchange rate was being
manipulated by the government and maintained that appreciation of the currency
would make life even harder for the 210 million people still living on less
than $1 a day in China but have only a limited impact on the Sino-US trade
imbalance.
Bo attributed China's trade surplus to global trade patterns and not
specifically to the yuan-dollar exchange rate. "If the US doesn't import from
China," Bo said, "'it needs to import from other countries, even at higher
prices, resulting in a bigger trade deficit."
As expectations of further yuan appreciation rise, so too it seems does the
perception gap between Chinese and Western leaders. For many in the West, it is
an open-and-shut case: the undervaluation of the currency is unfair and
unjustified, especially for a nation that is now a member of the World Trade
Organization, and it must stop.
For Beijing, the issue is more complex: how can China's policymakers bring the
country's still-fragile economy into the 21st century without creating
dangerous inequality and social unrest? From a Chinese perspective, a one-off
revaluation of the yuan does not make economic sense and would also be seen as
a massive cave-in to the West, particularly to the United States.
So what is the future of yuan appreciation? China's equity market has enjoyed a
bull run this year and, while regulatory reforms and new blue-chip listings
have been driving forces, bets on yuan appreciation have also been a factor in
recent weeks. Nothing is certain, but analysts would not be surprised by an
average annual appreciation of 3% over the next several years.
Kent Ewing is a teacher and writer at Hong Kong International School. He
can be reached at kewing@hkis.edu.hk.
