Role of yuan in a rising China

By all yardsticks, the domination of the US, Japan and the European Union in the world economy is declining while that of emerging economies — especially China — is rising. According to a book by economist Mr Arvind Subramanian, in dollar terms, Chinese GDP, even with a reduced growth rate of 6-7 per cent, will significantly surpass by 2020 the GDP of the US growing at 2.5-3 per cent. Though the Chinese per capita income will still be much lower than that in the US, according to Mr Subramanian, within the next couple of decades China may very well be the number one economic superpower on the strength of its higher level of GDP, higher share of global trade and its big net creditor position (while the US has become the world's largest debtor).

Already, the Western world expects China to play a significant part in rescuing the European Union by buying bonds issued by the troubled EU countries. It is also urging China to maintain the global growth momentum by shifting from export-led growth (which reduces demand and growth in other countries) to a more domestic consumption-driven growth strategy (which would also boost demand and growth in other countries).

China, on its part, is willing to play some role in this global rescue and rebalancing effort (while not missing this opportunity to put the blame squarely on the West for the mess), provided the Western world gives China ‘market economy status' without delay so that it can get unconditional MFN benefits as a WTO member. In addition, Western powers should refrain from pressuring China to revalue yuan at a rate faster than what China wants to do in its self-interest. In fact, yuan has appreciated by about 7 per cent against the dollar since June 2010.

Bigger role

There is absolutely no doubt about the economic ascendancy of China as also its greater assertiveness in international affairs. No matter whether the US Congress finally passes a Bill condemning China as a “currency manipulator” and threatens to impose countervailing import duties (mostly as pre-election politicking to appease local constituencies), the US administration's hands (to take any meaningful action against China) are tied by the debt ropes held tightly by China. A related question is being raised: Can yuan be a major global reserve currency within the next 10 years? After the World War II, the US emerged as the number one economic, political and military power replacing the UK and as a by-product, the dollar became the world's number one reserve currency.

The US derived an “exorbitant privilege'' (to use Charles de Gaulle's words) whereby it could buy goods from other countries simply by printing its national currency, which no other country could do. China is the world's largest holder of dollar reserves.

One of China's biggest worry is that the purchasing power of these enormous reserves which China has built up (by running huge trade surpluses helped by undervalued exchange rate) to access food and natural resources (which are becoming increasingly scarce globally) in future would decline if the dollar suffers a fall.

Clearly, it would be in China's interest if China can use its national currency yuan to buy goods and services from abroad and avoid the need to build more dollar reserves.

Trade payments in yuan

China is already taking some steps in this direction. For example, it is allowing neighbouring countries to settle trade payments in yuan (instead of hard currencies such as dollar or euro) in an effort to create and expand a virtual yuan zone.

It is encouraging state-owned Chinese banks to provide yuan loans to foreign companies on concessional terms to buy Chinese goods or invest in China.

Recently, the Indian government allowed yuan-denominated borrowing by Indian companies (subject to a ceiling) as the terms of borrowing are better than that on loans from the US or European banks, specially at a time when fund flows from European banks are drying up as a result of bad debts.

China has opened an offshore market for yuan-denominated bonds in Hong Kong where MNCs such as McDonalds are issuing bonds to raise funds to expand in China. In other words, China is trying all means to diversify its market for goods and currencies away from the declining West to its neighbouring emerging nations.

Nonetheless, it is highly unlikely that yuan will be a major international reserve asset in the coming decade, substantially replacing the dollar. In the past, with the economic ascendancy of Japan and later of Eurozone, many observers predicted that the Japanese yen and euro would largely replace the dollar as global reserve currencies. That has not happened, despite yen and euro being fully convertible currencies. The Chinese government is not showing the willingness to remove all restrictions on international financial flows to make yuan fully convertible or to allow a market-determined exchange rate (though some gradual liberalisation is likely to take place with time).

Under the more likely scenario, yuan will be increasingly used in Chinese trade with other emerging Asian countries.Is China's rise good for the world? To the extent China provides manufactured goods at low prices to the world, consumers all over the world are benefiting. High international commodity prices have also been largely due to China's high growth and demand.

Huge Chinese savings invested abroad is keeping interest rates low, fuelling consumption, investment and growth, even in hitherto neglected African countries. Cheaper Chinese capital equipment in construction, power and telecom sectors are keeping cost of infrastructure development lower in countries such as India.

If that helps to reduce the cost of Indian exports of goods and services to other countries while reducing imports of heavy machinery from the West, the overall multilateral trade balance of India may improve, though it would worsen vis-à-vis China.

India should bargain for more market access in sectors like IT and pharma (in which India has proven comparative advantage) in return for allowing more Chinese exports and investment into India.

(The author is a former Professor of Economics, IIM, Calcutta.)

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