Two conferences I attended in Beijing last month revealed a sea change in the Chinese thinking on the evolution of the international monetary system and the role China expects to play. India needs to judge whether these plans are well-grounded and realistic or largely a diversionary play. If they are judged to be serious, India will need to decide how it should react.
Two years ago, in the depths of the financial crisis, the Chinese were busy fending off charges that their trade and exchange rate policies played a key role in causing the crisis. Accordingly, they sought to shift the narrative away from the role of the “savings glut” in generating global imbalances, a view famously popularised by United States Federal Reserve Chairman Ben Bernanke.
In Dr Bernanke’s view, US’ macroeconomic policies played a largely passive role in the build-up to the crisis. Other countries, notably emerging markets in Asia and oil exporters, built up large net financial positions in the US financial markets. The US economy adjusted to these large net inflows by a corresponding widening of the current account deficit. In other words, the main source of the problem lay outside the US.
In response, the Chinese seized upon the privileged position of the US dollar in the global monetary system as the key contributor to global disequilibrium. In their view, the willingness of the rest of the world to hold dollars had permitted the US to indulge in unsustainable fiscal and monetary policies to the detriment of global stability. As America’s major creditor, the Chinese were also fearful of the long-term reliability of the dollar as a store of value in either domestic or global terms.
Accordingly, at that time the Chinese laid great stress on the need for the global community to generate alternatives to the dollar as the core reserve currency, in part by enhancing the role of the International Monetary Fund’s Special Drawing Rights (SDRs) as well as rebalancing the currency composition of the SDR to include emerging market currencies, notably the Chinese renminbi.
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Much water has flowed under the bridge in the intervening two years. In the Anglo-Saxon world employment growth remains anaemic. In continental Europe the German-speaking core is thriving, largely by exporting to Asia, notably China. However, the travails of peripheral Europe are proving to be a huge distraction and are preventing the euro from consolidating its position as a robust rival to the dollar. In their eagerness to ensure that the euro survives, the Chinese authorities have agreed to buy Greek debt currently being scorned by the private market.
Within China, while the economy has rebounded, inflation has emerged as a persistent problem. More importantly, though, the authorities have had time to fashion a political response to the vulnerabilities in their growth strategy revealed both by the global crisis and by domestic restiveness on a number of fronts. This response is best encapsulated in the 12th Five-Year Plan, which was finally approved in March this year.
China has already embarked on the first step of the journey by liberalising renminbi accounts for Hong Kong residents and by encouraging issuance of bonds by international organisations and foreign corporations in the renminbi also in Hong Kong. The authorities are also encouraging direct settlement of bilateral trade imbalances through the use of the renminbi rather than the US dollar. The next stage would be greater liberalisation of inbound capital inflows much along the lines of our foreign institutional investor policy. In due course (a time frame of 15 to 20 years was mentioned), the renminbi could become an important investment currency. I got the unmistakable sense that China had shifted its focus from reforming the global monetary system that it sees as asymmetric, precarious and unfair to engaging with the system as a major player.
What has been presented so far is not much more than a declaration of intent, one that obscures the many difficult decisions that lie in the way. Japan and Germany are large and successful trading economies which have actively resisted internationalisation of their currencies. Most impartial observers would judge that today India is ahead of China in areas such as the management of its exchange rate, and in access to its equity markets by outside investors. Arguably, India’s banks are stronger and better managed than China’s despite the latter being enormously larger. And though the Chinese financial system is currently bigger than ours, India’s is likely grow faster over the coming decades.
India will, therefore, face two issues in the years ahead. The first is how to respond and the second is how to compete. On the first, issues will soon arise on how to position ourselves with respect to settling our bilateral trade with the Chinese, or on holding significant quantities of renminbi-denominated securities as part of our official reserves. We would also need to take a call on the inclusion of the renminbi in the SDR basket, and the weight to be given to the renminbi in any Asian Currency Unit. It may be impractical to insist on symmetric treatment of the rupee in all these contexts, so pragmatism will need to be deployed.
The second issue is even less straightforward. The case for developing a strong international financial centre in Mumbai was cogently expressed in the Percy Mistry committee report, and promptly rubbished by the good and the great. The shenanigans of international finance in the intervening period have scarcely strengthened the case. Following a serious internal debate, the Chinese have apparently decided that they wish Shanghai to be the next New York in order to serve their own long-term interests, despite the short-term costs. The debate needs to be relaunched here as well.
The author is country director, India Central, International Growth Centre
Member, Prime Minister’s Economic Advisory Council
suman.bery@theigc.org
Views expressed are personal