March 03,2010

Yuan Appreciation Is Necessary, and Best in April

By Scott Zhou, Shanghai

The topic of RMB exchange rate appreciation is subject to serious distortion. Chinese government officials, economists, investors and even ordinary consumers have readily declared that that the yuan is undervalued. The very mention of RMB appreciation, however, seems to link one with pressures from the US, Japan, or Europe, and the starting of any discussion of the pros and cons of RMB appreciation tends to lead not from the point of view of China's own interests, but whether it suits the needs of other countries, particularly the US.

While it is only fair that China's trading partners are able to voice an opinion about matters that affect them greatly, RMB appreciation must first be considered from the perspective of China's own interests and from its own economic policy needs. Seeing past the fog of purely nationalistic reaction to foreign pressures, common sense tells us that RMB is undervalued in this period as China's national strength has increased after this round of crisis.

While the government's strategy has been to delay the appreciation as longer as possible, appreciation expectations for 2010 are becoming deeply rooted on the streets, where the main question concerns the timing.

China should choose RMB appreciation of around 3% in the first half year. April might be a good time. Politically speaking, the two big meetings, the National People's Congress and the Chinese People's Political Consultative Conference, will have just ended, and the Shanghai World Expo will be soon to open. And  officials of both China and US government are preparing for the the Strategic and Economic Dialogue in Beijing in May. The return of the exchange fluctuation range between RMB and the basket of currencies before the financial crisis would be beneficial to management of international capital flows in the short term, slowing down the excessive piling of exchange reserves.

Appreciation is related to the "exit" policy. The yuan peg to the relatively lowly US dollar through the financial crisis has had a stimulating effect on China's monetary, fiscal and industrial policy. As the global economy enters a "new normal state," the government's vast stimulus packages need to be withdrawn, which means that the reform of the RMB exchange rate mechanism should be back on track.

In 2010, the growing risk to China's economy will be inflation and economic and market volatility due to the yet unset global economic recovery, a situation that is complicated when coupled with the country's goals of structural adjustment. As China has now chosen to begin its "exit" policy, taking the initiative to allow RMB appreciation will help China to stabilize its position and achieve economic recovery and sustainability.

The advantages for RMB appreciation are several. It will tend to inhibit excess capacity and reduce exports, thus promoting domestic supply. Importing good-quality consumer goods at lower prices will promote domestic demand. It will inhibit input inflation, and promote balance in the domestic economic structure. Incidentally, it will also help reduce emissions by inhibiting exports by high-energy-intensive industries.

The dollar-pegged exchange rate system leaves China's currency policy open to the influence of international capital flows and volatility in the RMB exchange rate. It makes it hard for China's economic internal and external balance to benefit from exchange rate adjustment.

RMB appreciation will be a cause of concern over its impact on exports. In the short term, unemployment may rise in export industries, and stubbornly pegging to the US dollar will keep the cost of long-term economic imbalance  high, contrary to the objective of structural adjustment. The share of China's export products in the global market, however, has risen during the world economic turmoil. It is demand in the international market rather than the RMB exchange rate that has pulled China's exports. The competitive edge of China's manufacturing rather than the exchange rate has decided China's export competitiveness.

In the short term, in coastal areas, the base of Made in China, especially the Pearl River and Yangtze River Deltas, there have actually been labor shortages. RMB appreciation seems unlikely to increase unemployment.

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