Weakening yen for a pegged yuan

China-bashing is back and with US presidential elections next year, it can only gather momentum in America. Now the Chinese currency is under assault — both verbal and speculative.
US treasury secretary John Snow, the US Federal Reserve Bank chairman Alan Greenspan and a couple of American Senators have called for a revaluation of the yuan/renminbi.
The Europeans, Japanese and the South Koreans have joined the chorus. Influential investment banks have put out research reports suggesting that a revaluation is both needed and is imminent, although a few like Morgan Stanley have taken a contrary view.
Unlike India which has a ‘‘managed float'''' of the rupee, the yuan is pegged at 8.28 to the US dollar, although it is allowed to vary within an extremely narrow band of 8.276-8.28. It has always been at the centre of debate.
The roots of the East Asian financial crisis of 1997-98 have been traced back by some scholars to the hefty devaluation of the yuan by 50 per cent in mid-1994. During the crisis and its aftermath, however, China earned plaudits for holding the peg and for dispelling fears that it would devalue yet again.
But why, when it was praised for currency stability then, is it being criticised for currency stability now? Two major factors account for the view that the yuan is grossly undervalued: The phenomenal rise in forex reserves and huge inflows of foreign capital; and persistently high growth rates of both GDP and of exports, especially to the US and Europe.
China''s foreign exchange reserves have increased impressively: From $217 billion in January, 2002, to $340 billion in July, 2003. Andy Xie of Morgan Stanley has taken the view that China''s forex reserves tend to rise in tandem with capital inflows rather than trade surpluses.
FDI flows are strong and relocation of manufacturing capacity continues, helped in part by the absence of currency risk. In addition, overseas Chinese are pouring money into acquiring properties at home. The perception that the yuan is undervalued and can only appreciate in the long-run is leading to a significant return flight of capital of both non-residents and residents. Will this prove to be a self-fulfilling prophecy?
China has a huge trade surplus with the US (over $ 100 billion in 2002 and likely to be $ 120-130 billion in 2003). The dollar has fallen steeply in global markets (25 per cent against the euro and 10 per cent against the yen in the past 18 months) because of the very large US current account deficit that is now at around 5.5 per cent of GDP. As the dollar has fallen in relation to the euro, China''s competitiveness in European markets also has increased. As the dollar weakens, China gains.
What will the Chinese do? Fearing a revival of deflation — it is just escaping from it and with a fragile financial sector that is in worse shape than India''s — China may to do nothing, except widen the trading band or make it a ‘‘crawling'''' band. Movement to a floating exchange-rate system like in India is not on the cards. There are other options. Foreign exchange controls both the current and on the capital account could well be eased.
A disinvestment programme to sell something like $240 billion of government holdings in state-owned enterprises is on the anvil.
As China''s commitments to the WTO begin to unfold themselves more fully, import demand will also increase. This is already beg inning to happen and China actually ran a small trade deficit in Q1 of 2003. Regional monetary arrangements could also get a boost as East Asian countries think of alternatives to investing in low-yielding US treasury bonds.
However, the more China grows, the more will be the pressure for a revaluation. How long will it hold out?