China starts to feel the heat of the European debt crisis

China starts to feel the heat of the European debt crisis
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First Published: Tue, May 18 2010. 11 58 PM IST
Updated: Tue, May 18 2010. 11 58 PM IST
Hong Kong: The pain of the European debt crisis is spreading as the plummeting euro makes Chinese companies less competitive in Europe, their largest market, and complicates any move to break the Chinese currency's peg to the dollar.
Chinese policymakers reached a rough consensus early last month about breaking the dollar peg and letting the currency, the renminbi, rise in value somewhat, according to people close to Chinese currency policymakers. Uncoupling the currencies would make US goods more competitive against Chinese products. But for various reasons, China has not yet put that policy into place.
And in light of the euro's fall, such a move could be difficult. Letting the renminbi rise against the dollar would also mean a further increase in the renminbi's value against the euro, creating even more problems for Chinese exporters to Europe.
The euro has plunged against the renminbi in recent weeks.
The steep rise of the renminbi prompted a commerce ministry official in Beijing to warn on Monday that China's exports could be threatened.
The official's comments were the most explicit yet on the implications for China of Europe's recent financial difficulties. The comments also suggest that even China—the world's fastest growing major economy and increasingly the engine of global growth—is not immune to the crisis that started in Greece and threatens to spread across much of Europe.
“The yuan has risen about 14.5% against the euro during the last four months, which will increase cost pressure for Chinese exporters and also have a negative impact on China’s exports to European countries,” Yao Jian, the ministry's spokesman, said at a news conference in Beijing, according to news services.
It is a potentially awkward moment. US secretary of commerce Gary Locke is in China this week leading the first cabinet-level trade mission of the administration of President Barack Obama.
Some economists warn that China may face more problems. The biggest reason Chinese exports plunged early last year was not weakening demand in industrialized countries, but a sudden, temporary disappearance of trade finance from Chinese and foreign banks. The availability of trade finance could easily become a serious problem again soon, said Dong Tao, the chief Asia economist at Credit Suisse.
Chinese exporters rely very heavily on bank letters of credit to finance their shipments. The availability of the letters of credit is closely linked to overnight lending rates between banks. When banks have trouble borrowing money themselves—as has been happening as a result of worries about European banks’ possible losses from the region’s sovereign debt crisis—they tend to cut sharply the issuance of letters of credit for trade finance.
The banks see that as a quick, easy way to conserve cash without violating the terms of other financial obligations, such as established lines of credit for big corporations.
Interbank lending rates surged late last week and on Monday and must now come back down very quickly to persuade banks to keep issuing letters of credit, Tao said. "Without trade finance, trade won't happen," he said.
The renminbi is rising along with the dollar against the euro. The Chinese government has continued to intervene heavily in currency markets in recent weeks to prevent the renminbi from rising against the dollar, maintaining an informal peg of 6.827 renminbi to the dollar, the level since July 2008.
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First Published: Tue, May 18 2010. 11 58 PM IST