The People's Bank of China (PBoC) surprised the market with its announcement over the weekend to end its currency peg with the dollar as it reintroduced the scheme that pegs the renminbi (RMB) against a basket of currencies - a move that has been widely welcomed internationally. During the past six months, the RMB has been a scapegoat, taking heat from the protectionists of the West for its "inflexibility" leading to the slowdown of global economy recovery. By taking the initiative, China shook off this charge from Western politicians and more importantly, rewrote the agenda for the G20 meeting, to focus on the source of the problems: the debts of the developed economies.
Even though China did not bow to Western pressure to carry out a large scale, one-off appreciation of the yuan or to expand the trading bands of the RMB, as many has expected, the market overreacted with the PBoC's currency peg announcement, as the RMB rose almost 0.5 percent Monday, which prompted traders to sell US Treasuries and increase equities and commodities positions.
The sell-off of US dollar assets makes a strong case, as a large-scale appreciation of the RMB would prove devastating to the greenback and disturb global financial stability. With an accumulated 17 percent appreciation against the euro this year that's already priced in and the diminishing current account surplus of China, the path of the revaluation of RMB should continue in an orderly manner.
The Chinese economic data for May has shown the domestic economy has been growing at a healthy pace, with inflation slightly over target. A moderate appreciation of the RMB should be able to boost domestic consumption and help control inflation. Commodities that are crucial to the future development of China would also be imported at controlled and reasonable prices. All of these benefits would, however, be at the cost of the exporters.
For years, exports have been the pillar of the country's economic development, which feeds hundreds of millions. Although surging labor costs and currency appreciation are eroding exporters' competitiveness, the increased purchasing power of the RMB over time will eventually begin to ease the inflationary pressures on labor costs. The European debt crisis has affected the demand for Chinese goods and poses uncertainty for the sector. Yet, under a controlled pace of appreciation and given the ability to provide subsidies or tax relief, the Central Government should be able to relieve the pain of the sector.
The calculated move of Beijing was wise and came at the right time - one that will benefit the economy more than hurt it. The re-peg against a currency basket offers Beijing the flexibility and stability to insulate the RMB from extreme volatility in the forex market. The new policy signals that the Chinese economy is slowly walking out of the shadow of the 2008 financial crisis while it marks a turn from an export-oriented toward a more diversified economy.
While the action has been interpreted by some observers as a pre-G20 meeting gift to the West, especially the US, the future movement of the yuan depends on the speed of GDP growth and structure of the economy. The yuan is still undergoing structural development toward becoming an international currency; however, the priority remains ensuring the stability of the domestic economy and the harmony of Chinese society.
The author is a visiting professor at Asian International Open University, an international financial commentator at NOW Business News Channel and founder of www.wongsir.com.hk. The opinions expressed are entirely his own.
(HK Edition 06/23/2010 page3)