the much-awaited revaluation of the Chinese yuan happened
last Thursday when the world was least expecting it. The
yuan, also called the Renminbi, was de-pegged from the
US dollar and from now on will be pegged to a basket of
other words, theoretically at least, the value of the
yuan would move in tandem with the values of the currencies
of its largest trading partners. The composition of the
basket of currencies has not been disclosed and going
by the opaque ways of Chinese government it will remain
a state secret.
Chinese government also announced a marginal revaluation
of 2.1 per cent for the yuan against the US dollar. The
more than a decade old rate of 8.28 yuan to a dollar was
changed to 8.11 with effect from Thursday the 21st of
move came after relentless pressure from the US, which
accused the Chinese government of enjoying an unfair trade
advantage by keeping the currency undervalued. An undervalued
currency means exports from the country would be cheaper
in overseas markets while imports into the country would
be costlier making it difficult for overseas companies
to sell in the domestic market.
calls for tightening the screws on China grew substantially
in the US in recent months as Chinese companies moved
in to acquire established US companies like Unocal and
Maytag. There was talk of allowing these deals to go through,
provided China allowed its currency to appreciate to the
satisfaction of the US.
legislative bills were introduced recently in the US Congress,
calling for punitive tariffs on imports from China if
the yuan was not revalued. The proposed tariffs were as
high as 27.5 per cent.
last time the Chinese government changed the value of
its currency was in 1994, when it devalued the yuan by
33 per cent against the US dollar. The performance of
the Chinese economy in the intervening 11 years till now
was nothing short of spectacular and beyond anyone's imagination
back in 1994.
1994 and 2004 the Chinese economy expanded three-fold
from $540 billion to over $1.6 trillion, in absolute terms.
Both exports and imports increased more than five-fold
while trade surplus went up from $5 billion to over $30
The Chinese have always maintained that the fixed exchange
rate has helped them enormously in weathering the Asian
currency crisis of the '90s besides helping overall economic
growth. The stable exchange rate did encourage large capital
inflows from abroad which helped the country in building
its infrastructure and manufacturing capacity.
theory that the Chinese gave in to US pressure and revalued
the currency is too simplistic. They are known to take
aggressive positions when it comes to protecting their
interests. Then why this revaluation now?
the fixed exchange regime helped the country, it also
brought in problems of another kind. It led to fiscal
imbalances on the surplus side or a problem of plenty.
The accretion to forex reserves in the last few years
has been much higher than the FDI inflows. This suggests
that short term money flows speculating on a possible
yuan revaluation have gone up substantially.
bring in funds ahead of the revaluation to benefit from
capital appreciation. A 10 per cent appreciation in the
local currency would mean a 10 per cent return for the
overseas investor. (Similarly, FII's investing in India
benefit if the rupee appreciates against the US dollar,
which may be the reason for a part of hedge fund investments
of the economic growth in China is export led. After growing
at a furious pace for over two decades, the government
is trying to bring down economic growth to prevent overheating
and ensure stable longer term growth. Despite their best
efforts, exports rose to record levels in the first half
of the current year and growth remains above 9 per cent.
revaluation may make some of the low value added exports
from China less price competitive in the international
markets. Therefore exports of goods which compete only
on price with very low margins may come down even if only
marginally. More value added exports, which typically
have higher import content or are less price sensitive,
would be less affected.
Most analysts expect the Chinese government to let the
yuan appreciate further in near future. This is reflected
in the non-deliverable currency futures market where yuan
is quoting at around 7.75 to a dollar for 1 year forwards.
2 per cent appreciation can hardly make any difference
to the fiscal problems faced by China. It may in fact
make matters worse by attracting more short term inflows
in anticipation of a bigger appreciation in future. Therefore,
analysts believe that bigger revaluations would definitely
the Chinese government has dismissed all such speculation
about further appreciation of yuan. It has categorically
stated that no further revaluation is being considered
in the near future.
bigger appreciation in the value of the yuan, say by 10
per cent, could lower the economic growth in China by
up to 2 per cent. Most of this slowdown would happen in
the form of lower exports of less value added labour intensive
has to maintain sufficient growth in employment to address
the regional disparities and the growing aspirations of
its people. It can ill afford a sudden drop in growth
rates and employment which could potentially lead to political
and social unrest.
India where citizens demand a lot from the government
but do not expect much, the Chinese expect their government
to deliver though they may not demand publicly. Chinese
politicians would know very well that the stability of
their political system depends on managing rising expectations.
10 per cent appreciation would also mean a large capital
loss on China's bulging forex reserves. Assuming that
a large part of its reserves are invested in dollar assets,
the loss could be in the region of $50 billion. Even China
cannot afford such losses.
it is difficult to believe that the Chinese would let
the yuan appreciate substantially and suddenly. The currency
would most likely appreciate, but it would be a slow and
highly measured process.
on global economy
The Americans have been the most vocal in demanding the
revaluation, but ironically they are likely to suffer
much of the pain in the short to medium term if China
is to satisfy their demands. Americans have been blaming
the Chinese for most of their economic ills while enjoying
the benefits of low priced imports from China and other
of the significant factors keeping US consumer prices
down is the low cost imports of consumer goods from China.
Wal-Mart and other discount stores would not have been
half as successful without these cheaper imported goods.
supplying the US with low priced goods, the Chinese and
other Asian governments finance this US shopping binge
by buying dollar assets, mostly US Treasuries.
more expensive yuan means higher prices for Chinese goods
which would in turn put pressure on US domestic inflation.
This would lead to higher interest rates which would affect
the real estate boom in the US, one of the prime drivers
of economic growth there.
large fall in the value of the dollar would force most
Asian central banks to move out of their dollar assets.
This would in turn dry up liquidity in US and push up
interest rates and further increase inflationary pressure.
This would be the case if the yuan is to appreciate the
way the Americans are demanding. Ironically, this is the
ideal solution to correct the fiscal imbalances in the
the short to medium term this is less likely to happen.
Instead, liquidity flows into China and other Asian countries
would rise in anticipation of further appreciation in
Asian currencies. The central banks of Asian countries
would mop up these flows to prevent their currencies from
appreciating and hence would accumulate more dollar assets.
Therefore, the unsustainably high US current account deficit
would remain high till the US economy makes the structural
higher liquidity flows into Asia would keep interest rates
in the region under check. Even a marginal slowdown in
the Chinese economy would ease the pressure on regional
inflation through lower prices of commodities and other
less vigorous Chinese economy would also have a significant
impact on crude oil prices. The current record prices
have a significant speculation premium, betting on sustained
growth in demand from China and India. On the first indication
of a slowdown in Chinese demand, much of this premium
Apart from some low value textile goods which are highly
price sensitive, no other segment of the Indian industry
is likely to benefit significantly from the marginal appreciation
exports like iron ore, finished steel and other metals
could theoretically benefit from the lower costs for Chinese
importers after the currency appreciation. However, the
positive impact would be more than offset by the downward
pressure on international prices of these commodities
when Chinese growth slows down.
could benefit much more if western importers start sourcing
more from the country to reduce their risks. Uncertainty
over the Chinese currency may encourage some of them to
build deeper relationships with Indian suppliers as a
longer term strategy, even if Indian exporters are less
significantly, US and European manufacturing companies
may now look at India as an alternate location for future
plants. Further appreciation in the yuan would make low
margin manufacturing and assembly operations in China
signs of this are already visible with large electronic
contract manufacturers coming up with plans to start operations
in India. Even chip manufacturers, including Intel, have
started looking at India favourably.
all these potential benefits would accrue to the country
only if we get our act together on the critical issue
should also pray that the yuan would neither appreciate
too fast nor too slow. A sharp appreciation could be too
harmful for the entire region while a very slow movement
would not be disruptive enough to offer us any competitive