Clamor for yuan appreciation unwarranted
Updated: 2010-12-21 07:02
(HK Edition)
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Criticism of China's reluctance to rapidly appreciate its currency is nothing new. What is new is the outcry about China unfairly favoring its export sectors. There has always been griping on this subject, but the complaints have never been so vociferous.
Such criticism is unwarranted. Consider the situation from China's perspective: First of all, this was not a crisis of its making - it therefore has no obligation to jump on the grenade and make itself the victim of persistent twin deficits in the US and some other Western economies.
There is no reason for China to force a significant appreciation of its currency simply to demonstrate its commitment to global rebalancing. China views the Plaza Accord adopted in late-1985 by Japan as a morality tale it is keen to heed.
The Plaza Accord essentially sank the Japanese economy after 1985. Growth momentum in the country never recovered as Japan entered its "lost decade". Unless China wants to fall into the same trap it should avoid giving into the clamor for rapid yuan appreciation.
Instead of focusing on nominal exchange rate movements, a discussion of the real exchange rate is a better starting point for a global rebalancing.
The yuan has appreciated more than 24 percent against the US dollar since China loosened its peg with the US dollar in July 2005. In light of the rising cost of non-tradable resources in China, the real exchange rate is expected to appreciate even more rapidly in 2011.
The demand-supply ratio shows that the labor market is almost saturated and optimized. The days of China enjoying huge surpluses of labor are gone, to be replaced by tight demand for labor and sustainable wage growth.
Wage increases in China have contributed to cost-push inflation. Meanwhile, growth momentum in the US remains frail. The differentiated inflation outlook will push up the real exchange rate of the yuan. Based on the IMF's estimate of a 2.3 percent inflation rate in the US next year, the real exchange rate appreciation of the yuan will accelerate, picking up to 6.7 percent in real terms in 2011, higher than the 5.0 percent nominal appreciation we call for. Sectors with thin margins and low added-value will encounter setbacks.
Meanwhile, cheap non-tradable goods in China are becoming increasingly expensive. The rising cost of industrial land will be the next issue. Compared with residential and commercial land prices that have risen significantly, industrial land prices have lagged. Any increase in industrial land prices will lead to higher production prices, which in turn will contribute to domestic inflation and export prices.
The Central Government is generating greater revenue from the use of its land, which is facilitating income redistribution through the funding of expansionary fiscal policies. Not only does this make cheap non-tradable goods (ie land) less cheap but it will boost the real exchange rate.
China's reputation as the "world's factory" evolved from a favorable business landscape characterized by low labor and land costs coupled with loose environmental standards. With China's growing affluence, this landscape has changed: labor costs are on the rise and so is the cost of land.
Lest it suffer severe margin contraction, China has to get with the times and make structural changes within its economy that favors the production of high-end and more value-added products. This process will favor the country's high value-added export sector at the expense of OEM (original equipment manufacturer) companies.
China's trade surplus has always been at center stage when talking about global imbalances. This issue will some day become more of a sideshow as China moves away from a trade-centric growth model. Going forward, its main growth drivers will be domestic consumption and investment.
The author is an associate director and economist at CCB International Securities Ltd. The opinions expressed here are entirely his own.
(HK Edition 12/21/2010 page2)