China’s latest currency caper

China’s latest currency caper
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First Published: Tue, Dec 02 2008. 10 32 PM IST
Updated: Tue, Dec 02 2008. 10 32 PM IST
Shrinking demand in the major markets in the US and Europe as well as a severe financial crunch have brought Asia’s famed export engine to a halt. The Indian government said on Monday that exports in October were 12.1% lower than they were 12 months ago. Exports are either slowing or shrinking in most other Asian countries.
In this situation, China’s decision to guide the yuan down against the US dollar is significant. The People’s Bank of China has been holding the yuan steady these past few months even as many other Asian currencies, including the rupee, have slipped against the dollar. That hurts Chinese export competitiveness even as there are reports of factory closures and layoffs in the southern provinces. The initial decline in the yuan is in all probability an attempt to keep Chinese exports competitive and also a weapon against social unrest in the export zones of that country.
It is yet not clear whether Monday’s move is a strategic shift in Chinese trade policy. But other Asian countries will be worried. A sharp devaluation in the Chinese currency in 1994 led to a loss of export markets in countries such as Korea, Thailand and Malaysia, and was one of the factors behind the Asian economic crisis of 1997.
Competitive devaluations could be damaging in these circumstances—a race to the bottom. These are early days, but Asian central banks would do well to engage in some economic diplomacy to ensure that the realignment of currencies is not chaotic. The Reserve Bank of India will have to be party to the solution.
There are broader global challenges as well. The problem of global imbalances—the American trade deficit and the Chinese trade surplus—has to be tackled if the global economy is to avoid another bout of volatility and uncertainty. That would require two changes: a more expensive yuan and higher domestic savings in the US. Both will hurt immediate growth in the respective countries, but will be needed for the sake of long-term economic health.
China has cooperated in recent months. But its own severe slowdown may force it to walk away from the game. The change in its exchange rate policy may be an advance indication.
Is Asia close to exchange rate trouble? Tell us at views@livemint.com
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First Published: Tue, Dec 02 2008. 10 32 PM IST