CHINA’S YUAN POLICY COMES UNDER FIRE
JANE FOLEY
RESEARCH DIRECTOR, FOREX.COM
BY ALMOST everybody else’s standards, an annual growth rate of 8.9 per cent in the third quarter would be an opportunity to break open the champagne and put on the party hats. But expectations for Chinese expansion had been higher and this “disappointing” figure was enough to see investors lose, at least temporarily, their appetite for risk.
But with China still easily on course for achieving growth of at least 8 per cent this year, perhaps more interesting than its GDP figures is the increasing number of calls for China to rein in its very accommodative fiscal and monetary policies.
Only a few months ago the market was anxious for confirmation from the Chinese government that a loose fiscal policy would be maintained in order to keep the global recovery on track and risk appetite underpinned. Beijing has continued to provide these reassurances but there are now increasing worries that loose policy could be sowing the seeds of a fresh asset price bubble within China.
Last week China’s central bank acknowledged the build up of inflationary pressures. And as a consequence of increased evidence of rising price pressures, calls for a tightening in policy in China are building.
There has been a consensus for some time that Chinese policy should be oriented away from export dependence. The present strength of retail sales in China does suggest that domestic demand is rising but this is likely to be the direct result of the fiscal stimulus.
The combination of high savings rates and export-led growth, which have helped fuel global imbalances in recent years, could potentially maintain these imbalances once the global recovery gathers pace and Chinese fiscal stimulus is removed.
CONVINCING CORRECTION
A firmer exchange rate should provide a more convincing correction mechanism and this could play a part in a move towards tighter policy in China over the coming years. While the long-debated topic of an exchange rate adjustment in China was put on the back burner during the financial crisis, now that euro-dollar has touched the elusive 1.50 level and the dollar index is back to 14-month lows it is likely to receive renewed attention.
Comments from Eurozone officials over the past month or so have made it clear that they are worried about the euro bearing the brunt of the downward adjustment in the greenback. This appears to be a reference to the “undervalued” Chinese yuan and implies that a change in China’s exchange rate policy would make a rise in euro-dollar a little bit easier to stomach.
That said, the Europeans will have to tread carefully. While it seems likely that the importance of China as a trading partner will continue to grow over the next few decades, the US is still the Eurozone’s second largest trading partner after the UK. Eurozone exports to the US from January to July 2009 were still more than double exports to China in the same period, although imports from China were 25 per cent greater than those from the US. Of particular note is that imports from China are now significantly greater than those from the UK and this will underpin concerns about the impact of the soft yuan going forward.
SQUEEZE HIGHER
While the surge in imports from China in recent years may be a source of significant concern, any implicit change of focus by European officials towards the yuan may be interpreted as suggesting less interest in the value of euro-dollar. This could trigger a significant squeeze higher in the pair, which would undo the success of recent verbal interventions in reducing volatility in this exchange rate.
To make matters worse, given the tendency of sterling-dollar to trade in a relative contained band (recently between $1.60 and $1.70) it is likely that any further upside in euro-dollar would increase the probability of euro-sterling remaining at relatively high levels also. Such a development would further accentuate the strength of the effective Eurozone exchange rate.
It is very likely that Chinese policy will be a key topic in upcoming G20 meetings. It is also feasible that these meeting will prove to be a stepping stone towards another adjustment in China’s exchange rate policy.
But further oral communication from Eurozone officials in support of the US Treasury’s strong dollar policy will be needed to ensure that any further rises in euro-dollar remain orderly.
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