The Hindu Business Line : US-China currency war: Change in the tenor of debate

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US-China currency war: Change in the tenor of debate

K. SUBRAMANIAN

In last month’s Strategic Economic Dialogue with China, the US Treasury Secretary had lost the moral high ground from which he could sermonise on exchange rates. With the sub-prime crisis having global implications and threatening to slow growth, the US could no longer blame the Chinese for financial imbalances, points out K. SUBRAMANIAN.

When the US authorities, the Senators especially, commenced their currency war with China way back in 2001, it had all the froth and ferocity of a street-play. It is interesting to observe the changes in the tenor and decibel levels of the play in recent times. There seems to be a better understanding of the problems faced by both. More importantly, there are shifts in power balance moderating stridency. The Third China-US Strategic Economic Dialogue (SED) held during Dece mber 10-12 provided good evidence of this.

The US Treasury Secretary, Mr Henry Paulson, carried with him the usual wish-list, which included concerns over trade balance, product safety, and opening of capital markets, energy and environment. Truly, product safety commanded higher priority for both. The US side had to take care of the public outcry over substandard or hazardous imports from China; and China, in turn, had to safeguard its exports to the US and other countries by demonstrating its efforts to ensure quality standards.

Exchange rate was indeed on the list, but on a lower key. Unlike Senators back home, Mr Paulson is not a hawk on the currency issue. He is more than aware of the complex issues the Chinese have to contend with. Based on his earlier interactions, he felt that he had an understanding that while he would not precipitate the issue, the Chinese, in turn, would hasten the yuan appreciation.

He returned to the US after the dialogue, fully convinced that Beijing was committed to a stronger yuan. He assessed that China’s policymakers realised that a stronger exchange rate would help them to fight inflation.

He did not seek specific commitment on the yuan. As he said, “The pace of appreciation has increased over the past year. I’ve talked to the Chinese enough that we have agreed we don’t talk about how fast is fast. We agree with the principle (of appreciation).” There were other reasons for this change in the mood.

Sub-prime effect

Mr Paulson had lost the moral high ground from which he could sermonise to the Chinese on exchange rates or financial markets. The sub-prime crisis originating in the US is engulfs the globe and threatens to slow down growth. The weak dollar causes havoc with other countries in Europe and Asia. The US could no longer blame the Chinese for the financial imbalances. They had to address more issues back home.

In the SED, as Financial Times (December 12, 2007) reported: “Beijing turned the tables on the US on Wednesday after years of criticism from Washington of its handling of the Chinese economy, warning of the serious implications of the weak dollar, recent US interest rate cuts and the sub-prime crisis.”

Mr Chen Deming, the incoming Commerce Minister, explained how the failing dollar had pushed the costs of imported resources and was a destabilising factor. Even so, he did not oppose a stronger renminbi but argued that it should not appreciate “excessively” until Chinese businesses and banks got adjusted to a more flexible exchange rate regime.

Mr Zhou Xiaochuan, the Governor of the People’s Bank of China, added, “For China, what we worry about more is that very accommodative US monetary policy could give rise to a new burst of excess liquidity in global markets.”

Mr Paulson had reasons to be content with some of the assurances on reforms he secured. It was agreed that there could be equity participation in companies engaged in equities and brokerage. There was an in principle for equity participation in China’s banks. China also agreed to permit qualified foreign-invested companies, including banks, to issue yuan-denominated stocks. All these are agreements in principle and details are to be spelt out in due course.

There was a lot of heat and dust over many issues such as rising protectionism, product safety, piracy, etc. Ms Wu Yi, Vice-Premier, who led the Chinese delegation, was aggressive in attacking the restrictions imposed by the US on exports to China and over 50 anti-China Bills pending in Congress.

Against these, it was evident that the yuan rate had ceased to be a hot issue. Even for Senators, it had turned into an issue with lower returns than domestic issues. As MarketWatch put it, “A big critic of China, Sen Charles Schumer, Democrat (NY), has shifted his megaphone to the housing and credit crises.” (December 19, 2007.)

Within a week after Mr Paulson’s return to Washington, the Treasury released its semi-annual report to Congress on ‘International Economic and Exchange Rate Policies’ on December 19.

The report did charge that China intervened heavily in foreign exchange markets to maintain an artificially low value for its yuan, but concluded that it did not meet the legal definition of a currency manipulator. It recognised that yuan was appreciating but was not content with the pace of appreciation.

Well-managed

It took note of the challenges faced by China and how its exchange rate policy contributes to increasing domestic liquidity, notwithstanding repeated hikes in interest rates and reserve requirements. It added, “China should significantly accelerate the appreciation of the RMB’s effective exchange rate in order to minimise the risks that are being created for China itself as well as the world economy.” The tenor was more advisory than censorious. One may reasonably relate this stance to the deliberations in the SED and elsewhere. The yuan has risen by 3.4 per cent in 2006 and is being adroitly managed. Much to the surprise of market watchers and analysts, on December 29, it touched 7.3015 to a dollar, the strongest since the end of the dollar peg in July 2005. The median estimate of 28 analysts surveyed by Bloomberg was for a low of 6.88 by the end of 2008. Is China lowering the shutters?

According to reports, senior Chinese officials have confirmed that the yuan would continue to appreciate. They are said to be studying the issue. It is clear that the decision on yuan appreciation is related to China’s overall economic environment and outlook.

Under the new policy of rebalancing the economy, China feels confident that loss of exports could be compensated by increase in domestic demand and growth. It is also confident that hot money could be handled with its substantial reserves and changes in tax laws. However, it seems the threat of inflation nudges them to use currency appreciation as a tool. While China is not yielding to external pressure, it does seem to recognise the value of the advice given by the US Treasury and some other experts on monetary economics.

Inflation rising

China’s inflation rate has reached an 11-year high. Its consumer price index jumped 6.9 per cent and the government is alarmed over the political impact of higher food prices. The Peoples Bank of China has moved the monetary policy from ‘stable’ to ‘tight.’ To curb overheating, it has imposed limits on lending. It increased its interest rate during 2007 five times and reserve ratios 10 times! These are not considered effective and, as with our own Reserve Bank of India, the Chinese authorities seem to have decided to look at the yuan appreciation as a tool to control inflation.

Perhaps, there is a policy shift. Some analysts see it as a sign of China’s growing confidence. For long, indeed too long, has China been avoiding the “impossible Trinity” and has come to accept it on pragmatic grounds. The added advantage is that it could make peace with the US and its Senators and avoid acrimony. It would mark the beginning of a new phase in the currency debate.

(The author is a former Finance Ministry official with extensive experience in international, trade and finance matters.)

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