Chinese Yuan: A strong international currency on the horizon

Syed Ashraf Ali The name 'yuan' — the basic unit of the Chinese currency, renminbi -- does not readily strike a chord in the ears of many of us here in Bangladesh. We will, however, soon begin to see it carving a big niche in the world financial arena alongside the mighty US dollar, Euro, the European Union's common currency-and yen, the currency of the Asian economic power house, Japan. The optimism for the yuan's baptism into an international currency stems from the tremendous growth of the Chinese economy throughout the last two decades and a half. From 1989 to 2013 China's GDP (Gross Domestic Products) recorded a fantastic annual growth rate of 9.2 per cent reaching an all time high of 14.2 per cent in December, 1992. In recent years, however, the growth rate has receded to a lower but still respectable level of around 7.5 per cent. For a country with a population of over 1.34 billion, it translates into a huge output growth, in absolute terms, year after year. What is most remarkable is that the growth has been more or less sustained even amidst the recessions that otherwise engulfed the world economy following the onset of financial meltdown in 2008. In the international arena, China's progress is equally impressive. It has already edged past Germany to become the second highest exporting country, behind only the USA. While China's export volume reached a staggering $3,867 billion in 2012, its huge balance of payments surplus of about $420 billion represents a hefty 2.8 per cent of its gross domestic product (GDP). In the meantime, its foreign exchange reserves snowballed to an astronomical number of $3.3 trillion at the end of 2012. In spite of the strong economic indicators, China is not interested to propel all too soon its currency to the global circuit of free floating exchange rates. It keeps the Yuan artificially low against the dollar and, by extension, other international currencies, to sustain the momentum of growth in exports. The huge inflow of foreign currencies earned from export of goods and services is soaked up by the People's Bank of China through purchase of dollar from the market. It sets a daily reference rate for the Yuan based on market makers' quotations. Through this process of intervention, the Chinese have deliberately kept its currency weak. The interventions also led to the country's central bank accumulating a prodigious amount of foreign exchange reserve of over three trillion dollar, way above the second highest reserve of about a trillion dollar held by Japan. Another reason why the Chinese maintain a tight grip on the value of yuan is to protect it from the speculators who have earned the notoriety of dislodging the targetted free floating currencies from their moorings through speculative and arbitrage operation, often by means of non-deliverable contracts in the futures market. International leaders have criticised the Chinese government for keeping the value of the yuan artificially low, because an artificially undervalued yuan has serious implications for international trade. Some annalists estimate that the yuan is undervalued by as high as 40 per cent. An undervalued yuan makes it attractive for the importers world wide to buy from China while making it difficult for exporters from other countries to penetrate into the Chinese market. Some analysts have estimated that China's weak yuan policy cost an estimated 1.4 million jobs in America alone, many in the manufacturing sector. American producers find it hard to compete with cheap Chinese goods dumped there at low price. The U.S. has tried many different ways to get China to adjust its position on the currency issue. Recently, the Senate passed a bill aimed squarely at the Chinese -- though officially targeting any country with a "fundamentally misaligned currency" — that would empower the government to impose import tariffs on Chinese goods if the exchange rate is not rationalised. However, the US does not seem to be in a hurry to antagonise China through retaliatory measures. Because, the Americans also derive benefits from a weak yuan that helps the Chinese to build up huge dollar reserve which they roll back mostly in the U.S. for investment in securities and other forms of government obligations. In effect, it means that China is lending money to the United States and helps the latter to fund its massive budget deficit and service the escalating public debts. The consumers in America as well as other developed countries also enjoy the benefits of cheaper Chinese goods, as they do with cheap priced ready made garments exported by Bangladesh. Every coin, it is said, has two sides. On the flip side of the undervalued Chinese coin is the threat to trigger inflation in its domestic economy. China's recent inflationary problem is exacerbated by its artificial currency exchange rate. Besides, economic growth has spurred private consumption at a breakneck speed while the labour costs are surging. As the people from the rural communities migrate en masse to the cities, a perceptible shift is taking place in the China's demographic, social and economic landscape. China's currency policy is essentially a subsidy to its manufacturing sector and subsidies tend to have familiar consequences. The protected industries get fat, soft, lazy and cannot compete once the subsidy becomes economically nonviable. China is, of course, conscious of the implication of maintaining a weaker yuan on the domestic economy. In addition, it has to reckon with the euro-American threats of retaliatory measures. So, after keeping the yuan stable for a decade, China allowed its currency to strengthen 21 per cent from July 2005 to July 2008, including an initial, single-day gain of 2 per cent. Appreciation was then halted for almost two years to help exporters endure a global recession and the currency has advanced 10 per cent against the dollar since controls were loosened on June 19, 2010. By October 16 this year, the yuan further strengthened to 6.11 against the U.S. dollar. Since China launched the exchange rate reform in 2005, the real effective exchange rate of RMB has risen over 30 per cent. Many observers believe that China needs a floating exchange rate to tackle various domestic problems as also to respond to the call of its trade partners to avoid currency manipulations. There are also strong speculations that China is working towards reaching that goal within 5 years. What does a stronger yuan mean for Bangladesh? The yuan is getting stronger and when the Chinese authorities take their hands off the brake, it will get stronger still. Bangladesh cannot remain oblivious of the problems and opportunities that this scenario presents. The stronger yuan and rising labour costs in China will not only strengthen Bangladesh's competitive edge for apparel exports to the world market but will also open the opportunity for exports to China itself. However, it will mean bad news for the consumers as they will not enjoy the benefits that come from availability of an almost unending array of Chinese goods at a very cheap price. The banking system including the central bank should also gear up to deal with the Chinese currency for investment of funds and maintenance of yuan accounts with the Chinese banks for settlement of payments. The government may also take a lesson from the Chinese experience and go easy on patronising industrial enterprises with unnecessary incentives and subsidies unless these are absolutely essential in the interest of the economy and not for gaining political mileage. The writer is a retired executive director of Bangladesh Bank. [email protected]