As global currency wars intensify, calls grow louder for China to weaken the renminbi to jump-start its sputtering export machine. The exchange rate appreciated 6% against a trade-weighted basket of G10 currencies last year. In mid-February, the RMB was dubbed the second-most overvalued in the world, according to a Barclays index, just behind the Philippine peso.
At the end of February, however, the People’s Bank of China drove the RMB to its lowest level against the dollar since October 2012, while interest-rate cuts could drag the exchange rate even lower. Market players no longer view the currency as a one-way appreciation bet. After all, RMB weakening is supported by market fundamentals, reduces the risk of deflation, frees up domestic liquidity and boosts export competitiveness and corporate margins at a time of soft domestic demand.
A broad coalition, from Beijing policy wonks and Guangdong industrialists to western economists, make this case. Lombard Street Research, for example, argues the renminbi would need to be devalued by 15% to 35% to maintain a fair value against the dollar.
Since exports account for a quarter of China’s GDP, this nominal price hike is inevitably painful. But a shift in China’s currency regime is a step in the wrong direction.
Need to retool
The global demand deficit and the urgent need to retool China’s economy away from financial repression and cheap exports aided by a cheap currency, means a stronger RMB is key in Beijing’s rebalancing act. A stronger renminbi would boost consumers’ purchasing power and help nurture a more efficient financial system. It would force manufacturers to focus on higher-value-add goods to boost margins, and would provide an incentive to build up the services sector.
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A cheaper renminbi also boosts exports, but by a more-limited margin than rival manufacturing centres, given the country’s status as the world’s assembly hub. In short, the nominal value of trade from China doesn’t take into account the high volume of imported inputs, from processing parts to raw materials, in its output. In addition, a weaker RMB could act as a relative price hike for its regional competitors at a time when global monetary policies remain worryingly misaligned.
Finally, and perhaps most ominously, an abrupt fall in the currency’s value could be the catalyst for disorderly capital outflows or, at least, a liquidity crunch, given the large, opaque debt burden on the Mainland and carry-trade-related activities in Hong Kong.
If China does refrain from joining the currency war, it would boost its reputation as a responsible post-crisis member of the international community. China would effectively become the post-crisis Germany the world has long coveted, thanks to its fiscal expansion, investment growth, higher wages and an appreciating currency. Still, Washington DC policy circles are unlikely to bestow Beijing with such an accolade anytime soon.