Keep RMB stable - for now
By Wang Yuanhong (China Daily)
Updated: 2004-09-03 13:34

A sensible currency policy is one of the most important ways a country controls its economy.

Economic development and international balance should both play a part in determining exchange rates.

A stable exchange rate for the renminbi provides a stable support for the economy to maintain its annual 7 to 8 per cent growth. It is also one of the main factors that propel growth in China's international trade, foreign investment and foreign exchange reserves.

In fact, the changes in the renminbi exchange rate could be said to reflect the changes in the Chinese economy.

By 1994, the renminbi was devalued against the US dollar by half its 1986 rate. But as the Chinese economy began to boom, it rose again. Between 1994 and 2002, the renminbi appreciated by 18.5 per cent against the US dollar.

Figures from the International Monetary Fund show that the renminbi appreciated by 21.5 per cent against the currencies of China's major trade partners between January 1994 and September 2002.

China's sustained, sound economic growth is matched by China's financial conditions and the supervision mechanism that is in place here.

As well as the surplus in international balance and increasing foreign exchange reserves, there are several other factors pressurizing the renminbi.

China's dual surplus in the current account and capital and financial accounts is a direct result of the nation's foreign exchange policy. This is also why the foreign exchange reserves have grown rapidly. The policy aims to keep foreign exchange within the country, and demand from banks, companies and individuals is thus suppressed. Meanwhile, individuals and businesses seeing weakening impulses make investments with foreign currencies.

The turbulence in the financial markets in Western countries is fast spreading globally. Expected returns on investments are shrinking. It means investors are now keener to sell their foreign cash to the banks rather than invest it.

The fairly high but stable interest rate of the renminbi also adds to the pressure of renminbi appreciation, and the difference in interest rates between renminbi and other currencies attracts overseas money into China.

But in the face of this mounting pressure on the renminbi, at least one point needs to be clarified: China's exchange rate policy is not the cause of global deflation and revaluing the renminbi will not ease deflation.

Despite its vigorous growth, China's GDP is only 3.5 per cent of the world's. China's trade takes up a mere 5 per cent of total global trade volume.

Multinational companies choose China because they are eyeing its huge market and its economic progress rather than the under-valued currency here.

Their choice is also why there is a rising trade deficit between the United States and China. The US used to import Asian products from Japan, the Republic of Korea and China's Taiwan Province. As the international industry giants move their manufacturing bases from these countries and regions to China, China sees more trade surplus to the US and with it, more trade deficit to these economies.

China's robust growth has played a key role in lifting the economy, both of the world and of East Asian countries, out of the financial crisis of the late 1990s. This growth could be delayed by an appreciation of the renminbi and East Asia could suffer economic turmoil.

In fact, a revaluation of the renminbi would not have a particularly good influence on the economic recoveries of the US, Japan or Europe, a stance Goldman Sachs supports.

In other words, if the renminbi were raised under the wrong conditions, it would not benefit any other country - while China would have to suffer huge shocks in different sectors within the country.

Positive effects include the fact that consumer goods and production materials produced in other countries would get much cheaper when measured against the renminbi.

Renminbi appreciation will also attract more foreign investment, reduce the costs of international loans and encourage manufacturing facilities to move into inland areas where labour costs are much lower.

But revaluing renminbi hastily or dramatically would have negative effects on the Chinese economy, which must not be overlooked.

First, the manufacturing sector could see remarkable damage. China's competitive advantage in the manufacturing sector is in its low labour costs.

Exports would suffer from a rapid rise, and in the agricultural industry, cheaper imports would take an upper hand over domestic crops, with relatively reduced prices.

The direct aftermath would be a large-scale migration of farmers, especially those in eastern areas, into the cities and towns.

The service sector might also be influenced. Once the currency is raised in value, the financial market will become attractive to short-term cash. Given the country's current ability to control financial risks, swathes of hot cash would probably trigger a financial and economic crisis here.

Residents could find their money has a better purchasing power after appreciation. But when the negative influence on exports, international balance and economic growth fully emerge, employment prospects and incomes of residents will be damaged, ruining quality of life and standards of living.

Employment would be put under far more pressure once the currency is revalued. The major providers of new jobs are export-orientated and foreign-invested companies. With exports suppressed after the appreciation, employment opportunities would be reduced, adding extra pressure to the already sombre employment situation here.

Being still at an early stage of industrialization, China is far from being the world's workshop. Its competitive advantage lies in its low labour costs, not products and businesses of core competency.

The economy has to be developed further, more jobs must be created and the pressure of deflation has to be eased.

In all, considering China's entire current situation, the time is far from right to revalue the renminbi.

There are advantages and disadvantages, but the former are outweighed by the latter.

Since academics have not reached a consensus about the factors and their roles in deciding the exchange rate, we should stick to two main criteria when judging a currency's exchange rate: Whether the economy is advancing smoothly under the current exchange rate level, and whether economic progress is sustainable under the exchange rate arrangement.

If the answers are both positive, the exchange rate arrangement should not be dramatically changed.

And this is today's case in China.

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