Is China about to revalue its national currency, the renminbi? As its economy heads into a second year of rapid recovery from the economic crisis, rumours are circulating again that a rise in the exchange rate, which has barely budged against the US dollar for two years, may be imminent. But if that happens, do not expect dramatic global consequences any time soon.
There are many reasons to think that a stronger RMB would be beneficial, for China and for the world. It could help combat growing inflationary pressures and deter the hot money inflows that bedevil the country’s domestic monetary policy. It would also boost Chinese consumers’ spending power by making imports cheaper and spur industries to upgrade to higher value-added products – both stated government aims.
A revaluation would be widely welcomed abroad, particularly in the US, where China’s heavily managed exchange rate has long been bitterly criticised. It is blamed for artificially depressing the price of Chinese exports, generating big current account surpluses and contributing to the build-up of global financial imbalances that some economists believe fuelled the crisis. By letting its currency strengthen, China could reduce the risk of bruising conflicts with trade partners.
However, these are mostly hopes, not certainties, and many of them are likely to be disappointed. For one thing, any renminbi appreciation will almost certainly be modest and gradual. A big move would be bound to face powerful resistance from politicians in the country’s export-oriented coastal provinces, who fear it would add to the millions of job losses already caused by the crisis.
Furthermore, it is doubtful that even a sizable revaluation of, say, 30 per cent, would be enough to curb China’s persistent external surpluses. A recent study by researchers at Columbia University, based on analysis of long-run data from 170 economies, fails to find any consistent correlation between movements in exchange rates and current account peformance.
Linkage is especially tenuous in China’s case because so many of its exports consist of items – such as consumer electronics products - that are assembled from imported components. Revaluation would cut the cost of the latter in local currency terms, limiting upward pressure on the price of China’s exports and consequently the probable impact on the trade surplus.
In truth, explanations for the country’s external surpluses mostly lie elsewhere. These stem mainly, not from unfair trading practices, but from the fact that China saves far more than it invests or spends at home. Like oil-rich Middle Eastern nations - which increasingly owe their wealth to Chinese demand - its economy simply cannot absorb all the money it makes, despite its dizzyingly high levels of fixed asset investment. The surplus cash has therefore to be exported. Much of it flows to the west, because that is where the world’s biggest, deepest and most liquid capital markets are.
It is anomalous that so much wealth is regularly transferred to rich countries from poorer ones. It is odder still that Chinese public opinion celebrates as a sign of strength the vast foreign exchange reserves amassed as a result of its external surpluses. In reality, the surpluses and bulging reserves reflect structural and policy flaws that have prevented the country’s citizens benefiting as much as they could from its economic success by holding down their living standards.
In order for them to share more of China’s prosperity, its economy needs to be re-balanced, to make consumption - not investment and exports – its main growth driver. Beijing has talked for years about promoting that shift. But progress has been slow and may well have been reversed by heavy reliance on investment, which generated almost all of last year’s growth, to power recovery from the crisis.
Re-balancing requires action on four fronts. First, savings rates must be lowered – not just in households, but in companies and the central government, which are now reckoned by many economists to be China’s biggest savers. Second, modernisation of the country’s distorted and primitive financial system should be accelerated, in order to ensure that savings are invested more productively and capital allocated more efficiently.
Third, household incomes must rise faster in order to support higher consumption, after several years in which they have grown more slowly than corporate profits. And fourth, more jobs need to be created by reforming and opening up services markets, which are potentially by far the biggest job creators but which, in China, are often dominated by politically influential state-owned enterprises that lock out private competitors.
This amounts to a formidable agenda. Even if China’s cautious current leadership summons the will to tackle it, braving likely opposition from powerful lobbies and entrenched vested interests, it will take many years to achieve. A renminbi revaluation – and better still, a steady move towards a more flexible currency regime – could contribute to positive structural change. But China’s foreign critics should recognise that on its own, it is not the magic bullet that many of them claim.
Guy de Jonquières - Senior fellow at the European Centre for International Political Economy. He previously worked for The Financial Times
