Analysis: China Pressured on Yuan

2005-05-18
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China's center of government, the Great Hall of the People, seen here in a closeup with the flip side showing former top Communist leader Chairman Mao Zedong on the country's largest monetary note, a one hundred yuan (or renminbi) note. Photo: AFP/Frederic J. Brown

WASHINGTON—China has vowed to resist foreign pressure to raise the value of the yuan, but analysts say the country is already experiencing the economic effects of delay—and that international expectations have been creating pressures of their own.

China broadened its foreign exchange market May 18, increasing the number of currency pairs traded. While officials made no link to future yuan exchange rate reforms, official media quoted a top economist as saying that a strong forex market was a prerequisite to exchange-rate reform.

Much of the pressure on the Chinese currency is felt in the form of rising levels of dollar holdings by Chinese institutions, known as foreign exchange reserves, experts told RFA in a series of recent interviews.

They have a big imbalance, the imbalance is getting larger, and my guess is the more the foreign pressure, the more likely they are to do it sooner rather than later. They have to evaluate all the costs and benefits of making a change in the exchange rate, but that's something that can't be avoided.

"The expectation is still there, because they're still accumulating large quantities of dollar-denominated assets," Dale Jorgenson, Harvard University professor of economics, told RFA.

"They're accumulating at a rate that has to be the source of increasing discomfort, because the dollar is not itself a terribly secure store of value," Jorgensen told RFA reporter Michael Lelyveld.

Banks borrow in overseas currencies

Last year, China's foreign currency reserves soared by U.S.$206 billion to nearly U.S.$610 billion, in part because banks are importing dollars and converting them into yuan.

Chinese officials issued a directive May 10 aimed at limiting the amount of foreign debt taken on by its banks, which had been borrowing in foreign currency in the hope of paying back loans with a stronger, re-valued yuan.

The yuan has been pegged to the dollar since the Asian currency crisis of 1998. But there are increasing complaints from U.S. manufacturers that China's exports compete unfairly with their products because the yuan is undervalued by as much as 40 percent.

Legislation before the U.S. Congress could lead to tariffs of 27.5 percent on all imports from China unless the yuan's value is adjusted, or allowed to float freely on global currency markets.

But Barry Naughton, a China specialist and economics professor at the University of California at San Diego, said the focus should be on China's own reasons for revaluing the yuan rather than on pressure from the outside.

"I think China is certainly in a position to let its currency appreciate, and I think the crucial thing is to recognize that in almost every aspect, it's better for China for its currency to appreciate," Naughton told RFA's Wu dialect service.

Moderate adjustment expected

"If you have slower monetary growth and a higher currency it makes it much easier stabilize the economy," he said.

Naughton said the revaluation would probably be quite moderate when it came, in the range of 7-10 percent.

Since the Bank of China has already shown that it can defend the currency at current levels, it should have little trouble backing up the new adjusted value and stopping more speculation after that, Naughton added.

"The benefit of having a more market-influenced currency is that people have to be concerned about movements up or down, and it makes it much harder for speculators to place one-way bets on your currency," he said.

Other analysts seemed to agree that a revaluation was inevitable.

Morris Goldstein, senior fellow at the Institute for International Economics in Washington and a former International Monetary Fund official, said that Chinese officials were simply hoping for an optimum time to revalue, judged in terms of domestic economic and political pressures.

Farmers' incomes a major concern

"I don't think the Chinese are different in that respect than other countries. Everybody would like to make a change at an ideal time, but that's not likely to happen," Goldstein said.

"They have a big imbalance, the imbalance is getting larger, and my guess is the more the foreign pressure, the more likely they are to do it sooner rather than later. They have to evaluate all the costs and benefits of making a change in the exchange rate, but that's something that can't be avoided."

I think China is certainly in a position to let its currency appreciate, and I think the crucial thing is to recognize that in almost every aspect, it's better for China for its currency to appreciate. If you have slower monetary growth and a higher currency it makes it much easier stabilize the economy.

Naughton said that a major concern for the government in keeping the yuan's value low is that it has helped farmers, who have been able to increase prices for agricultural products.

When the currency goes up, China's farmers will face more competition from imported food.

"As you know, the rural income gap has been very large in recent years and has been increasing. But the administration of Wen Jiabao has really made a very strong effort to narrow this gap and support the incomes of farmers, and this is one area where they've had significant success in the last year," Naughton said.

Dangers of currency speculation

Goldstein said a significant revaluation would trim the growing surplus in China's current account, which includes trade, investment income and other transfers, but it would not make a major impact on China's economy.

"I don't think it would make the Chinese economy grind to a halt by any means. It's growing over 9 percent. Maybe we'd see it go down to 7 percent or so," he told RFA.

But he warned of the dangers of attracting increased speculation with just a small adjustment in the region of five percent in the yuan's value.

"I think if they do a very small change, it's going to be probably worse than no change at all, because then I think many people in the market are going to reason that, well, this is just the first of many," he said.

"If you've got big disequilibrium and you don't eliminate it in one step but you keep going in small stages, that's the worst for expectations because people think one change leads to another and they're going to make even more money in the future by being in the [yuan]."

Original reporting by Michael Lelyveld. RFA Mandarin service director: Jennifer Chou. Produced for the Web in English by Luisetta Mudie.

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