International | Jun 29 2006
By Chris Shaw
The headline stories may have disappeared for the time being, but there continues to be pressure on China from both the US in particular and Europe to revalue its currency to help rebalance global trade.
A quick look at the figures shows why, as in May China’s foreign exchange reserves increased by another US$30bn to US$925bn, this despite attempts by the People’s Bank of China to slow the rate of accumulation by issuing more and more short-term debt. Some expect the trade surplus to continue expanding, Zhang Xiaoji of the State Council’s Development Research Centre suggesting it could grow for at least another 10 years.
It is argued by those on the wrong side of the trade equation with China that a revaluation of the currency would address this accumulation of reserves, but as HSBC’s Qu Hongbin points out, such an approach is too great a simplification. He argues China’s inflow of foreign exchange is in reality a reflection of foreign direct investment, which is itself a reflection of globalisation and China’s growing importance in terms of world production.
As a result, Hongbin suggests any appreciation in the currency designed to reduce such foreign exchange inflows would need to be so large it could actually damage the economy and in particular the agricultural sector.
Research by the China Development Bank and Tsinghua University suggests one solution is to maintain an undervalued currency, while imposing transaction limits on commercial lenders in terms of bond purchases, while introducing provisions for the lenders to borrow or deposit their reserves at discount rates as set by the People’s Bank.
In contrast, Hongbin suggests the People’s Bank needs to address the issue by stimulating private portfolio outflows, a process that has been made easier by changes to capital controls announced back in April that allow citizens and corporations to diversify somewhat into foreign assets.
On his estimates, an annual portfolio outflow of US$150bn would be enough to offset all the inflows, thereby removing the pressure on the People’s Bank to increase foreign exchange reserves.
Such an outcome could also have flow on benefits in Hongbin’s view, as he suggests it may assist in altering expectations for the currency. Additionally, it would help in establishing a two-way flow in China’s foreign exchange markets, which in turn would allow the market to decide the currency’s value.
The final benefit is it would help stabilise the banking system, as banks could then expand their fee-based earnings through the provision of products for those looking to invest offshore, which would strengthen earnings in the face of falling loan-deposit ratios.
