Thursday 22 February 2007

RMB: To revalue or not to revalue

The academic debate on whether China should revalue its currency continues.

Over at Market Watch there is a neat little article with a few facts and figures thrown in. The background on the economic implications of the year of the pig is unnecessary but worth reading (I am not sure this helps with the gravitas of the piece though).

Whither China in the year of the pig?

HONG KONG (MarketWatch) -- When it comes to the direction of bull and bear markets, generally investors know where they stand, but what to make of a pig?

This week marks a new Chinese New Year, the Year of the Pig, and in Hong Kong shops and restaurants are festooned with golden pigs to bring good fortune.

But soothsayers have been quick to point out this is actually a year of the fire pig marked by upheavals, changes of government and landmark political shifts. Not only is the Year of the Pig not matched with lucky gold, it is fire that sits on water putting the elements in conflict. Further this year's flames are not even a yang fire, symbolizing warmth of the sun, politeness and optimism. Instead it's a yin fire that signifies the spark of tension, conflict and even war.

I don't suppose these soothsayers are fully paid up economists?
For investors talking stock at Lunar New Year, it might be worth considering the last year of a yin fire was 1997 - the year of Asian financial crises when market bubbles burst and currencies collapsed across the region.

Looks like the market is a sell then.
Today, currencies and bubbles are again back in focus, with most eyes on trading goliath China and the sensitive position of its pegged currency in the global economy. If anything encapsulates a landmark political shift, a major move in China's pegged currency to the U.S. dollar since 1993 would surely fit the bill.
While a decade ago China won plaudits for resisting a me-too competitive devaluation as Asian currencies fell domino style, today the government has made it clear any change will be timed to serve its own interests. Could that time be approaching?
One prominent Sino-economist says he now expects China will opt for a faster than generally expected pre-emptive policy revaluation. In a paper released in recent weeks Chicago based economist David Hale says he expects a revaluation that will surprise on the high side, "with some movement perhaps around the time of the Chinese New Year in mid-February, or the 17th CPC Congress this fall. "

So this will be the Chicago based economist that has no relation to the economics department at Chicago but happens to run his own consultancy that happens to be in Chicago. Fine - he does have an MSc in Economics from the LSE after all. However, the analysis has a ring of truth to it:
A confluence of factors has combined to lead to a change in mainland thinking. For one, Chinese companies have coped well with a nearly 6% yuan appreciation since July 2005 to date. Exports, 25% of which are destined for the US market, have been strong and increased 27.2% year on year in the last quarter of 2006.

He also cites a change of tone in the Ministry of Commerce towards revaluation, which has long fretted about how profits would suffer at domestic firms.
Arguments that China needed a fixed exchange rate to safeguard its financial system now also carry last weight. Privatization of its three largest state-owned banks has improved the sectors health giving these banks a combined market capitalization of $460 billion, or 15.1% of GDP.

And for the Peoples Bank of China, traditionally more supportive of a revaluation in order to tighten monetary policy and dampen the export boom, arguably those arguments look more persuasive than ever.

There are some other interesting statistics:
China's trade surplus jumped nearly 75 per cent to reach a record $177.5 billion last year. Hale argues China now appears to have a structural current account surplus equal to 6-8% of GDP, and if capital spending were to suddenly slow, the current account surplus could rise to 10% of GDP.

Also, rampant money supply growth is being directly linked to the current gradualist approach of appreciation of the yuan, even by local economists. Yu Yongding, a former central bank advisor, warned in the past week that this risks encouraging more speculative money to enter the country.

'With the guidance of market expectations, foreign capital will continue to flow in, creating asset bubbles and even possibly leading to a financial crisis in China," Yu writes in the latest issue of the International Economic Review.

Of course, China has been acting to restrain money supply growth, raising reserve requirements for banks again last week the fifth time in the past 6 months as well as two interest rate increases. Headline inflation might suggest this is working as CPI recorded a modest 2.2% year-on-year rise in January vs. 2.8% in December.
Asset prices, however, tell another story. Both the red hot A-share market and record property prices are widely believed to be in bubble land and are being keenly watched by government policymakers.

Given some of the recent posts on this blog, an upward revaluation of the RMB would make studying in abroad cheaper and would no doubt make UK Universities and potential students happy. Education provision is, afterall, one of the UK's largest exports.

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