China: A Bit Of Theater Starring The Yuan

It looks like a post-reelection present for President George W. Bush. In the wake of the American vote on Nov. 2, Chinese officials have been signaling that Beijing is ready to adopt a more flexible currency regime -- just as Washington and U.S. manufacturers have long demanded. Suddenly the currency markets are abuzz in anticipation of a yuan revaluation, a move that could slow the onslaught of Chinese exports to the U.S.

Not so fast. Although some China watchers believe Beijing is ready to move towards a more market-based financial system, it's unlikely the Americans will get the stronger yuan they want. Indeed, when People's Bank of China Vice-Governor Li Ruogu said on Nov. 4 that Beijing "had already made a host of fundamental preparations" for exchange-rate flexibility, he was reiterating what the government has said for some 10 years -- that it has a policy of slowly liberalizing its exchange rate. He added that the PBOC intends to keep the yuan "basically stable."

The message is clear. China wants to introduce more flexibility into its currency system, and so stave off U.S. pressure. But any changes will be incremental, within Beijing's time frame, and designed to keep China as competitive as ever. Over the next half year, China is likely to widen slightly the narrow band within which its currency is pegged to the U.S. dollar. The impact would be a one-time yuan revaluation, perhaps by a couple of percentage points, as it rises to the top of the band. The government could also link the yuan to a trade-weighted basket of currencies rather than the U.S. dollar. But none of these steps would have a dramatic effect. "Making the currency more flexible does not equal freeing the currency," says Zhao Xijun, a professor in the School of Finance at People's University.

Why would the Chinese be content to tinker, given the calls for a major revaluation? One reason could be the consensus leadership style of the government under President Hu Jintao and Premier Wen Jia-bao. Adding much more flexibility to the yuan would require full agreement by China's top officials, and probably no one leader is willing to advocate the potentially destabilizing move toward floating rates.

Little Influence

Another reason is that although Beijing wants to cool the economy, it does not want to make companies operating in China less competitive. Even if the yuan edges up, labor costs will remain some 4% of those in the U.S. And because Chinese manufacturers import most commodities and components, a stronger yuan would lower the cost of materials. "Even if a revaluation were to have a negative influence on our exports, we also must buy many components from overseas," says Yin Weidong, a director at Zhejiang mobile phone maker Ningbo Bird Corp., which exports to France, Russia, and India. "So ultimately it would have little influence on our competitiveness."

The Chinese have other ways to take the upward pressure off their currency, which has attracted speculators. Beijing is allowing companies and individuals more freedom to exchange their yuan for foreign currency, which can offset the effects of speculative inflows of funds. "China needs to keep widening the band of people who can change money," says Hai Wen, deputy director of Beijing University's China Center for Economic Research. But for the Bush Administration, Beijing's noises on currency changes are likely to be more public relations than gift.

By Dexter Roberts in Beijing

Edited by Rose Brady

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