The value of the yuan might go down as well as up. That was the message from the People’s Bank of China when it announced last month that it was removing the dollar peg adopted in 2008 as an anti-crisis measure and returning to a managed float against a trade-weighted basket of currencies. To emphasize the point, on the first day of the new regime the PBoC left the reference rate unchanged at 6.8275 before allowing a series of small appreciations in the following week.
In part, the PBoC’s emphasis on currency “flexibility” might have been intended to discourage hot money inflows by making it clear that yuan appreciation is not a one-way bet. Yet the central bank also implicitly rejected calls by US policymakers for a revaluation of the currency. “With the balance of payments account moving closer to equilibrium, the basis for large-scale appreciation of the yuan exchange rate does not exist,” it said.
Many analysts disagree, quoting figures as high as 50% for the undervaluation of the yuan. Others, however, endorse the central bank’s assessment. “The Chinese trade surplus has declined continuously over the past two years,” says Frederic Neumann, co-head of Asian economic research at HSBC. “There is a slight undervaluation but nowhere near as drastic as it was five years ago, the last time the Chinese started the appreciation move.”
Domestic rebalancing
Minggao Shen, China head of research at Citi, says higher estimates fail to take into account domestic structural adjustments. “Wages are increasing in China and that will help to rebalance the structure,” he explains. “If strong wage increases lead to more domestic consumption that will take some pressure off the currency.”
China’s defenders also point to the decline of the euro. With the dollar peg in place, the yuan has already appreciated 14% against the currency of China’s largest trading partner since January. Ben Simpfendorfer, chief China economist at RBS, says some of the PBoC’s critics fail to take a global view of the problem. “The think-tanks who say the currency is 40% undervalued are looking specifically at what level would the yuan need to be to create jobs in the US.”
That is not to say that Chinese policymakers have no appetite for appreciation. Shen says the PBoC’s references to rising inflation and the need to stimulate domestic demand point to an adjustment of around 3% to 5% a year. “A gradual approach of currency appreciation together with some domestic adjustment should be the best for the Chinese economy and also for the global economy,” he says.
Yet this cautious policy might not be enough to placate US politicians. The PBoC might have staved off criticism at the G20 summit but with mid-term elections due in November the pressure to revalue is likely to return. “There’s an expectation that China needs to deliver over the coming months,” says Neumann. “Whether the Chinese move enough to satisfy US political demand remains to be seen, but they will hopefully move just enough to defuse the drastic action that some US policymakers are contemplating.”
