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Thursday, June 12, 2003

No to the Rinban Revaluation Drive

Andy Xie with some good reasoning as to why pressure for a Rinban revaluation should be resisted. Apart from the sound sense, what is the point in trying to throw the only global economy which has serious momentum off its dynamic path?

As the SARS crisis unwinds, markets are once again speculating on the renminbi peg to the dollar. The euro’s sharp appreciation against the dollar appears to have stalled. The theory is that, if the renminbi appreciates against the dollar, it would allow other currencies to appreciate further against the US currency. China’s high growth and rapid accumulation of foreign exchange reserves are cited as grounds for renminbi appreciation. However, I believe that neither stands up to scrutiny with justifiable grounds. China should not re-peg or float its currency until its financial system has been revamped, in my view.

First, the state of China’s trade balance does not drive its foreign exchange reserves. There has been no correlation between the country’s trade balance and its foreign exchange reserves. Indeed, China’s foreign exchange reserves have tended to rise faster when its trade balance is not favorable.

Combining China with Hong Kong gives us a similar and, in my view, more accurate picture. Between 1993 and 2002, their combined trade balance totalled US$96 billion, while their foreign exchange reserves rose by US$334 billion.Indeed, China could be running persistent trade deficit in the future. We believe its large trade surplus from 1997 to 2002 was probably an anomaly due to its SOE restructuring and its related deflation.The large bilateral surplus against the US should not be considered separately from China’s overall trade balance. Saudi Arabia runs a large trade surplus against the US. Should its currency appreciate against the dollar?

Second, capital flows drive China’s foreign exchange reserves. China has received over US$400 billion in foreign direct investment. In addition, overseas Chinese have been pouring money into China to purchase properties and other assets that have also contributed to the buildup of China’s net foreign asset position. Should China appreciate its currency to spend the capital inflows, as America has done? This is neither a reasonable nor a practical answer, in my view. China has a low level of wealth. No developing country that turns capital inflow into consumption has been successful in economic development. Further, the wealth level of Chinese households is below equilibrium level. Their savings are growing faster than GDP. Appreciating the currency may not increase consumption, but, instead, could just turn into deflation

Third, China is growing faster than other world economies. Should that be a cause for China to appreciate its currency? The answer is again no, in my view. Growth rates per se do not justify currency appreciation, although the difference between growth potential and actual growth rates does have an effect. If China is growing above its potential growth rate, its currency should appreciate. On the other hand, if China does not appreciate its currency under such a scenario, it would experience inflation, which would force real currency appreciation.There is no evidence to suggest that China is growing above its potential. On the contrary, there is plenty of evidence to suggest that the economy is growing substantially below its potential. Unemployment is serious and the situation may deteriorate. Starting salaries for college graduates are declining, and overcapacity is widespread. China’s potential growth rate is substantially above 10%, in my view, and the country has not achieved such growth for five years. As a result, we are observing trends in the factor and goods market that are associated with insufficient growth.
Source: Morgan Stanley Global Economic Forum

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