Every once in two to three months, every self-respecting international economist/columnist is expected to have something intelligent to say on the undervaluation of the Chinese currency, even if he has nothing new to say. So, Bare Talk will follow the tradition now.
We shall begin with facts. In 2009, three Asian currencies figured in the list of best performing currencies versus the US dollar. They were the South Korean won, Indonesian rupiah and the Indian rupee. This year, the list has expanded to five and the newcomers are the Malaysian ringgit and the Thai baht. The Chinese currency does not figure in the list in either year. China recorded—as per its numbers—a real gross domestic product (GDP) growth rate of close to 9% in 2009. Since it revalued its currency slightly and moved it to a basket peg in 2005, China allowed its currency to appreciate nominally for about three years and now it has been fully stable for nearly two years at $6.83 to the renminbi. Therefore, someone said that China had not really moved to a more flexible exchange rate regime. That is a reasonable quip.
If one opened Ft.com on Sunday evening, one could see the comments of Chinese Premier Wen Jiabao on the currency. He claims that the currency is not undervalued and that any pressure on China to revalue its currency amounted to protectionism. He may have a point. The US did that to Japan in the late 1980s and effectively precipitated the Japanese meltdown and two-decade-long stagnation. Many think that in the long run, exchange rate manipulation does not matter. They are right, but the problem is in defining the long term. In the short term, it matters and that could be quite long.
China’s devaluation of its currency in December 1993 was also a significant, if partial, contributor to the creation and entrenchment of trade and current account deficits in other East Asian nations caused by the sudden loss of relative competitiveness. Clearly, there were many other factors that caused the Asian crisis of 1997-98, but this was one of them.
The US, as Prof. Jagdish Bhagwati wrote recently in his blog, cannot pin the blame on China for the housing bubble and credit crisis. That is a cop-out. There were strong and considerable domestic factors that had been at work for more than two decades that culminated in the crisis.
Even if China revalues its currency, it is not in a position to help rebalance economic growth simultaneously in the US, in the euro zone and in Japan. After all, in per capita terms, it is still a developing country and its systemic financial sophistication, if any, is rudimentary. Hence China, as a matter of economic and international strategy, is right to stake its sovereign right on this.
The problem, however, is that there are other developing countries that have not grown at a rate of 9% in 2009. Most of them saw economic contraction. They are in Asia. In fact, a recent research report by Standard Chartered Bank showed that India ran a larger trade deficit with Association of Southeast Asian Nations (Asean) countries in 2009 than China did. In other words, India contributed more to Asean economic growth in 2009 than China did, even though the trade between the latter and Asean was five times larger than that between India and Asean countries.
Asean would have liked China to be a regional benefactor rather than a beneficiary. China’s trade balance with Asean countries has been shrinking steadily as it develops its manufacturing capabilities in light, medium and heavy manufacturing.
That is why Johns Hopkins Prof. Arvind Subramanian wrote some time ago that small, open economies with more poor people than China should voice their concerns over the latter’s exchange rate policy collectively. Over the weekend, Business Standard’s T.N. Ninan has urged India to do so. It is not clear if they would achieve the intended result or would be counterproductive.
The mere fact of foreign exchange reserve accumulation is proof enough of currency intervention. Given the massive size of the stock of reserves (nearing $3 trillion) and the inflow of reserves ($453 billion in 2009), the intervention too must be massive. Such an intervention cannot but be distortionary even for the Chinese domestic economy, regardless of what the rest of the world thinks about it.
These sizes would be surely tempting for American politicians and raise the danger of the US treasury naming China as the currency manipulator in its April report. The probability remains small, but is not insignificant. If it happened, it would be negative for the world in more ways than one.
While the US would be better advised not to look for scapegoats for its domestic economic travails, it is in China’s interest—as an aspiring regional hegemon in Asia—to revalue its currency sooner rather than later.
It is possible that the rhetoric of Premier Wen was meant to provide the political cover for some action on the exchange rate front. Investors can and should bet on it.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org