When, Not if, the Renminbi Will be Un-pegged

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Global Trade, Macroeconomics

The question of China’s exchange rate against the US Dollar is one that excites opinions in even the most parochial backwater of the US or Europe because it is perceived to be a major cause of blue collar manufacturing job losses to the emerging market. So the growing probability, indeed near certainty, that China will revalue its currency this year is sure to stimulate considerable speculation as to when and by how much.

Because of China’s size in the global economy the issue has become of significant importance for almost all its trading partners, led by the US, Europe and Japan. There is an almost universal clamor to take action but the authorities have resolutely declined so far. Indeed just last month Wen Jiabao, China’s premier, said he would “absolutely not yield to pressure for a stronger Renminbi according to the Financial Times.

After revaluing the Renminbi by 2% and removing the peg from the dollar in mid-2005, China allowed its currency to appreciate by more than 20% against the dollar until July 2008. Then the dollar peg was put into place as China tried to insulate its export sector from the financial crisis. But China’s exports are rebounding again, with recent figures showing exports growing in December for the first time since October 2008. According to the Financial Times, on an annual basis Chinese exports rose 17.7%.

The debate is not so much if but how the authorities will allow a rate rise. A gradual move, over months or years, could tempt large inflows of speculative “hot money into China, inflating domestic assets prices including stocks and property. But a sudden one-off revaluation could be seen as more evidence of policy tightening by the People’s Bank of China, which would send shock waves around the world potentially impacting asset prices of all kinds.

The imperative to do something appears in part to be driven by the continuing rise of reserves undermining the authority’s claims that a change is not necessary. Data last week reported in the FT showed China’s foreign exchange reserves, rose by $127bn in the fourth quarter to $2,400bn. To maintain its exchange rate, the People’s Bank of China takes the excess inflow of foreign funds from the market and channels it into its foreign exchange reserve account. To sterilize, or mop up, this liquidity, the bank issues central bank bills, apparently this bill issuance has risen markedly since November suggesting the accumulation of reserves is accelerating and exports are rising strongly.

The main losers of a currency appreciation would be China’s exporters but in terms of the authorities longer term objectives of stimulating consumption and controlling inflation a currency adjustment has a lot to commend it. A stronger Renminbi would make imported goods cheaper for ordinary Chinese and tend to reduce the cost of imported raw materials for industry lessening inflationary pressures.

The consensus seems to be action will be taken early in the second quarter and although the country favors gradualism a one off adjustment on balance probably carries less risks.

–Stuart Burns

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