A V Rajwade: No less competitive

WORLD MONEY

China's advantages are too many to be reduced by the yuan change

In all the media commentary in India about the change in the Chinese currency's exchange rate against the dollar, several things amazed me.

First, we have not devoted even a tenth of the space to the implications of the 20 per cent plus "real" appreciation of the rupee against the dollar over the past three years (11 per cent in nominal terms, and the balance by way of inflation differential) as compared to the 0 per cent real appreciation of the yuan (2 per cent nominal, but inflation was zero to marginally negative in recent years).

And this when we may well have a $50 billion merchandise trade deficit in the current year, and need employment and GDP growth, which flow from export growth, as badly as the Chinese "" if only more so!

Second, calls for a more "flexible" exchange rate of the rupee, whatever it means: a 40 per cent real appreciation against the dollar?

Third, an unrealistic euphoria about the yuan change as signifying a far more competitive Indian manufacturing industry, textiles, for instance.

What exactly have the Chinese done? To quote from the official announcement, they have introduced a "managed floating exchange rate regime....with reference to a basket of currencies".

The governor of the Chinese central bank described the 2 per cent change as an "initial adjustment". When this was read by the market as an indication of further upward adjustments, the authoritative People's Daily newspaper clarified that the policy is to keep the currency "basically stable" and cautioned speculators against putting a "huge one-way bet on the yuan's appreciation".

The forward discount on the yuan, in the non-deliverable forward market in Hong Kong and Singapore, promptly narrowed.

To my mind, the exchange rate change, at least at this stage, seems to be more of a political gesture ahead of the Chinese President's forthcoming visit to the US, than a major economic policy change.

The Chinese have responded to years of political pressure for a "more flexible" exchange rate policy, but without making much of a dent in Chinese competitiveness.

If the Financial Times is to be believed, the US authorities had privately indicated to the Chinese earlier that revaluation of around 10 per cent is needed to forestall the US Congress resolution to impose a 27.5 per cent duty on Chinese imports.

Clearly the Chinese are nowhere near heeding this so far.

One suspects that linking to a basket would have been undertaken even without external pressure: clearly it is more rational to link a managed exchange rate to a basket of currencies of the major trading partners, rather than to any single currency, something which India has done for the last three decades.

In any case, the call for flexibility is a blatant example of western double standards: The Europeans were silent when, for several years, the yuan appreciated against the euro along with the dollar, as a result of the same pegged exchange rate policy that they now criticise jointly with the Americans.

The American establishment has been criticising the Chinese for several years for "manipulating" the exchange rate to give unfair advantage to its exporters: this when the rate was rock steady against the dollar for a decade!

Not many have commented on one intriguing corollary of the basket linkage: should the dollar appreciate from current levels against the major currencies, the yuan could even fall below the 8.28 erstwhile peg, to limit the currency's appreciation in basket terms! On the other hand, if China realigns its reserves composition to parallel the basket, this would weaken the dollar internationally.

Would the new policy do much to reduce Chinese competitiveness in prices of manufactured goods? To my mind, hardly.

As it is, the real appreciation against the dollar is perhaps close to zero. And the Chinese seem to have built great competitive advantages through superb infrastructure, efficient supply chain management, even technology in some areas.

This will stand them in good stead independently of the exchange rate. In the end, the West may have got what it was asking for (a more flexible exchange rate), but not what it really wanted "" a less competitive Chinese economy.

If the West will not get much from the change, it won't give much of a boost to our competitiveness. While the rupee should not remain overvalued by 7 per cent in REER terms, as it currently is, another major stumbling bloc is our neglected infrastructure.

Port and airport capacities and the lack of efficient road/ rail networks on the needed scale to support them, have started constraining our export growth.

And, the policy wrangles, the vested interests, poor governance and a slow judicial system will ensure that there is no quick progress.

Email: avrco@vsnl.com