RIYADH, 16 May 2005 — The Chinese yuan is back in the news with rumors of an impending revaluation. Not a day has gone by in the last week or so with rumors that the move was coming. In the meantime, this speculation is attracting an ever-increasing amount of speculative capital inflow into China and creating further imbalances. The case for a revaluation of the yuan and the political pressure from America and other China’s trade partners is so intense that this speculation will probably not go away until the move takes place.
What are the issues? The pros and cons on the yuan revaluation?
The Chinese yuan has been pegged for a decade at 8.28 yuan’s to the dollar. By making Chinese exports cheaper in dollars and US exports to China more expensive, this gives China greater exports than is due. This “unfair” advantage has grown over time as the Chinese economy has been growing two or three times faster than the mature economies of the world in the last two decades. Critics, however, note that what matters is not the bilateral trade balance between China and the US (or any other country), but China’s total trade balance with all its trading partners.
Although, China has a surplus with America, it has a large deficit with its Asian trading partners. In effect, China has become the “funnel” through which China imports stuff from all around the region, adds value to them and then ships them to America, Europe and elsewhere.
Secondly, it is not just the trade balance that matters for currency valuation, but also capital flows. China not only has been attracting huge amounts of direct foreign investment in the last two decades, but huge inflows of short-term capital, which helps to keep the yuan up.
Ironically, speculation about revaluation of the yuan itself is attracting a large amount of portfolio capital inflows. And, thirdly, if one takes a longer view, the yuan may look expensive instead of being undervalued. Between 1994 and 2001, the yuan actually gained 30 percent, dragged up by a rising dollar.
In fact, those who accuse the Chinese of pursuing a cheap-yuan policy forget that during the East Asian crisis, China did not devalue its currency in line with most of its neighbors, despite the loss of its export-competitiveness at that time. Many independent analysts and economists conclude that China has a stronger case than the US and can be excused for taking its own pace. China is probably also testing the waters by occasionally floating seemingly contradictory statements. This is creating volatility in global forex markets that will not go away soon.
Meanwhile, this week’s release of the US trade deficit number was kinder on China but its own trade numbers may rekindle pressures to revalue the yuan. Year-to-date April, China showed a surplus of $21.2 billion compared to a deficit of $10.7 billion the same period of last year. And, a US-China trade war is looming.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)
