The Chinese, ever the adroit political animals have side-stepped criticism at the approaching G20 summit in Canada by announcing it will introduce a more flexible exchange rate policy. China’s central bank appears to be reverting to the foreign exchange system it introduced in July 2005, when it abandoned an explicit dollar peg. Â¨A recent Financial Times article explains the managed float system links the Renminbi to a basket of currencies of its main trading partners. In practice, economists say, the currency has mainly tracked the US dollar. Â¨Every day the central bank sets a reference rate for the Renminbi against the dollar. The Renminbi is then allowed to rise or fall 0.5% around that mid-point, although daily fluctuations have tended to be much smaller.Â¨ This Monday’s mid rate was set the same as Friday close, dashing any hopes for an early or fast adjustment. Previously the Renminbi rose gradually by about 21% against the dollar from 2005 to mid-2008 and the start of the financial crisis, but since then it has remained stable.
It is not expected to move as far this time although based on purchasing power parity the Renminbi is still undervalued by about 24% even after the dollar has weakened as much as it has over the last 18 months. China’s exchange rate against the euro has already appreciated 15% in recent months, raising worries about slowing exports to China’s biggest market.
In the short term, the currency may not move much at all. The timing is almost certainly intended to spike the US guns at the forthcoming G20 conference where China would have faced a barrage of complaints over its currency peg. China did the same last year raising the idea of replacing the US dollar as the international reserve currency in a carefully timed series of announcements to deflect attention from its policies in the run-up to the first G20 summit in April of last year. That proposal has been little discussed since, but it did have the desired political effect of shifting the focus back to the US economy.
Most economists agree China has to allow revaluation to boost domestic consumption and reduce growing inflation by bringing down real import costs. China though is concerned about damaging a still recovering export industry. Although the trade deficit has dropped in recent months many believe it will rise again late in the year if nothing is done about the currency. Indeed if the currency is not allowed to adjust appropriately then China may yet have it both ways a marginally higher exchange rate and continuing growth in export led surpluses. No doubt that is what Beijing intends.