Two weeks ago, in a move that pre-empted possible pressure on China about its exchange rate policy at the G20 Summit in Toronto, the People’s Bank of China announced that it would “proceed further with reform of the renminbi (RMB) exchange rate regime and to enhance the RMB exchange rate flexibility”. Since then, renminbi has appreciated just 0.6 per cent against the US dollar. To be sure, the word used is “flexibility” which, in theory at least, means movement either way; indeed a fall in dollar terms could occur should the currencies of its largest market, the European Union (EU), slump.
The objective of the move, as enunciated in a question-and-answer format on the Chinese central bank’s website, is “to stabilise the RMB exchange rate basically around an adaptive and equilibrium level, and in the meantime, improve China’s BoP situation, and achieve economic and financial stability”. One answer emphasises that “while furthering the exchange rate regime reform provides a great deal of potential for future benefits, efforts would also be needed to minimise possible negative impacts. First, it is important to avoid any sharp and massive fluctuations of the RMB exchange rate. As China’s BoP is now moving closer to a more balanced position, prices of labour, raw materials, land and other capital goods have become higher, which raises the cost of China’s export. The basis for a large-scale RMB appreciation does not exist as the RMB exchange rate is moving closer to its equilibrium level ...the RMB currency reform would be gradual, in view of varied degrees to which the corporate sector would respond to changes of the exchange rate. The purpose is to maintain an orderly process of industrial upgrading, maintain the international competitiveness of Chinese enterprises... . A large fluctuation of the RMB exchange rate would bring considerable shocks to the domestic economic and financial stability, which is not in China’s fundamental interest”. The concern about the competitiveness of the real economy, particularly its tradables sector, is obvious. So is the objective of the flexibility, in effect gradual renminbi appreciation. “Further reforming the exchange rate regime will also be supportive to job creation, particularly in the service sector. Exchange rate floating will turn Chinese exports to be high value-added product-based. More jobs will be created by extending the production chains through improved division of labour. In particular, the exchange rate will help improve resource allocation between the tradable and non-tradable sectors, and thus enable the service sector to absorb surplus labour from other sectors, particularly, tradable sectors”. This shows how cautious (or timid?) the Chinese are in allowing exchange rate flexibility; how conscious they are of the impact of the exchange rate on the real economy, despite having the world’s highest surplus on current account and exports, a fast-growing economy, and low inflation.
Now compare this to our brave attitude towards the exchange rate: Remember, we allowed the rupee to appreciate almost 6.5 per cent in April 2007, from a level which many thought was reasonably neutral in real effective terms. Moreover, last year, we allowed the rupee to appreciate more than 12 per cent in nominal dollar terms, even as we were hit by double-digit inflation and a gargantuan trade deficit. And, of course, we never refer to the competitiveness of the real economy while discussing the exchange rate policy. We talk of intervention to smoothen volatility, but aver that we have no level in mind, etc. Clearly, we are far braver than the Chinese. But, are we wiser?
G20 in Toronto
If China pre-empted one issue by its well-timed announcement on exchange rate policy, overall the G20 Toronto declaration seems to have moved well away from the ringing call for “global solutions to global problems” given by the first summit in November 2008. As the crisis of autumn 2008 recedes from the summiteers’ memories, national priorities and differences are coming into sharper focus. This was most clearly seen on the issue of fiscal consolidation, where there were two different groups: the US, Japan and India preferring a more gradual process; Europe, with Greece and PIIGS still weighing heavily on its mind, preferring a faster track. The major issues clearly are the risks of inflation versus deflation and of financial markets’ confidence in sovereign paper.
A related issue is global imbalances. In this context, recent macroeconomic developments in Europe clearly raise some questions. Both the sharp fall of the euro and fiscal consolidation will reduce domestic demand and imports, and increase the competitiveness of exports. One has seen estimates of $300 billion as the EU surplus on current account in 2010! If Europe, China, Japan are all to register large surpluses, who is the buyer of last resort? The US? And, for how long, without causing a run on the dollar? And if it’s not the US, then who? Will trade protectionism gather momentum, taking the global economy once again in the direction of recession/deflation? The G20 Summit has provided few clues to answers to these major issues.
