China Programme • Volume 14 • Number 23 • 23rd June 2010

China Loosens Hold on Currency Ahead of G20 Summit

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China’s central bank announced over the weekend that it would modestly relax its currency’s two-year-old peg to the US dollar, in a move calculated to defuse international tension over the yuan’s value ahead of the G20 summit in Toronto this week.

The surprise decision came only days after Chinese state media rejected US lawmakers’ calls for the yuan to rise, deriding them as the work of “baby-kissing politicians” seeking to make political hay by “blaming everything on China.”

It is unclear whether the move, which Beijing has made clear will not lead to any sudden appreciation in the yuan, will mollify Washington enough to stave off legislation targeting Chinese imports for what many US policymakers see as an artificially weak yuan that unfairly subsidises Chinese exports. Leading Congressional proponents of punitive action have vowed to press forward with sanctions legislation, but they may now find it harder to win support from their colleagues and the White House.

Beijing’s announcement came in the form of a short statement that appeared on the People’s Bank of China’s website on Saturday. The Chinese government “decided to proceed further with reform of the RMB exchange rate and to enhance the RMB exchange rate flexibility,” the statement said, using the abbreviation of the currency’s other name, the renminbi. The yuan would be linked to a basket of currencies.

No large jumps in the value of the yuan are likely. In its statement, the central bank said that in light of the country’s shrinking current account surplus, “the basis for large-scale appreciation of the RMB exchange rate does not exist.”

A separate statement posted to the central bank’s site two days later emphasised that a large fluctuation in the yuan was “not in China’s fundamental interest.” The statement made clear that a one-off revaluation was not in the cards, and that changes would be gradual, to minimise any negative effects on the corporate sector. The central bank said that the exchange rate regime that saw the yuan appreciate by over 20 percent from July 2005 until it was re-pegged to the dollar in mid-2008 had been a “success.” The new flexibility, it added, would be pursued for similar reasons: boosting industrial upgrading, controlling inflation and asset price bubbles, supporting the expansion of the services sector, reducing trade imbalances, and making growth less reliant on exports.

For all the emphasis on domestic motivations, the move is well timed to help China deflect scrutiny of its exchange rate policy at the Toronto summit. The US is hardly alone among G20 members in having criticised the level of the yuan; officials from other countries, including India and Brazil, have also urged Beijing to revalue.

Eswar Prasad, a Cornell University economics professor who was previously the top China expert at the International Monetary Fund, called Beijing’s move “canny,” since much of its effects remained to be seen.

“They’re taking away the political heat, but without significantly affecting their export competitiveness,” he told The Wall Street Journal.

Beijing had said that the yuan would be linked to a basket of currencies, but it provided no specifics about the composition of the basket - which is what would determine how the yuan moved, he explained. If the basket were heavy on the euro, which had declined sharply against the dollar (and thus the yuan) in recent months, a newly flexible yuan might even sink against the dollar.

“If the world now says, ‘Let your currency float against the dollar,’” Prasad told The Wall Street Journal, “the Chinese could say, ‘Do you really want it to depreciate?’”

A study released earlier this month by two experts at the Washington-based Peterson Institute for International Economics concluded that the yuan is still undervalued, but not to the extent that it was before. The authors, William Cline and John Williamson, said that based on IMF data for May 2010, the yuan needs to appreciate by 24 percent against the dollar. Last year, they put the figure at 40 percent. The bulk of the change was attributed to the reduction in China’s current account surplus.

How Beijing will allow the yuan to move remains to be seen. The subject of worldwide scrutiny, the yuan rose by a modest 0.42 percent against the dollar on Monday, departing the RMB 6.83 level around which it had hovered for nearly two years. But the next day, it fell 0.23 percent against the dollar, as Chinese state-owned banks purchased the US currency, in what was taken as a sign that the Chinese financial authorities would manage any shifts tightly. A report in The Financial Times quoted traders and economists as saying that the government would try to avoid setting up a “one-way bet” on upward movement by the yuan that would attract inflows of speculative capital.

It is clear, however, that a decline - or even a standstill - in the value of the yuan will raise hackles in Washington. Even before the yuan turned downwards on Tuesday, Senator Charles Schumer, one of the leading Congressional proponents of punitive action, including tariffs, against China, said he did not intend to halt his work to advance sanctions legislation linked to the value of the yuan.

“We intend to move forward as quickly as possible with legislation,” said Schumer, a Democrat from New York, in a statement on Sunday, reports Bloomberg. “Just a day after there was much hoopla about the Chinese finally changing their policy, they are already backing off.”

Other officials, both in the US and elsewhere were less sceptical.

“We welcome China’s decision to increase the flexibility of its exchange rate,” said Timothy Geithner, the US treasury secretary. “Vigorous implementation would make a positive contribution to strong and balanced global growth.”

The European Commission and the Japanese government also welcomed the Chinese central bank’s move, expressing the hope that it would lead to more balanced growth in the global economy.

ICTSD reporting; “Global Leaders Welcome China’s Yuan Plan,” WALL STREET JOURNAL, 21 June 2010; “Beijing allows renminbi fall to deter speculators,” FINANCIAL TIMES, 23 June 2010.