China's fancy footwork


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Far from bowing to international pressure, China's renminbi revaluation shows it is firmly in control of its own destiny

In a continuing dance with the global capital markets, China's government has learnt the steps with admirable speed. The latest sashay even wrong-footed its partner, caught on the hop as the rulers of the People's Republic announced one of their most significant financial reforms to date: the removal of the renminbi peg to the US dollar in favour of a basket of currencies.

That, plus a modest revaluation, brought some self-satisfied smirks from the US and talk in the international press of China having finally bowed to international pressure to revalue its currency.

China has done no such thing. Instead, in one rather clever move, it has achieved several useful aims. First, the immediate 2.1% revaluation, which will barely scratch the paintwork on China's gleaming economic engine or make the slightest impression on America's towering deficits, has nonetheless put paid to the more bellicose US howls for China to adjust its exchange rate. Second, China has demonstrated again that it is serious about its reform programme. Third, and most important, it has cleverly bought itself more time and flexibility in which to continue the reform of its financial system.

How so? Well, the devil is in the detail. In explaining the move, China's central bank governor, Zhou Xiao Chuan, was careful to note that the new basket of currencies was a reference only. Although he listed the currencies that make up the basket, he refused to disclose their weightings. The result is that China has actually given itself far more elbow room than it had with the US dollar peg. Since the market can only guess at the weightings and at what "reference" might mean arithmetically, China's central bank will be able to manage its currency far more anonymously than before.

Moreover, China remains in full financial control, since the capital account is firmly shut for the foreseeable future. The country's burgeoning foreign exchange reserves, already more than $700 billion, give it immense firepower with which to defend its new currency system. Although there has been some hand-wringing about China's need to rebalance its reserves from US dollars in favour of the basket, concerns are overblown. Rebalancing must be done, true enough, but no-one really knows by how much or by when. What they can be sure of is that China will not undertake the rapid rebalancing of reserves that some worry about, for fear of causing a dollar crisis that is in no-one's interests.

China has been smart, but it needs to be. The country needs all the financial flexibility it can find if it is to solve the systemic problems that remain, including the reform of its banking system, stockmarket, state-owned sector and securities industry, to name a few. A freely convertible yuan remains a fiction until these leaks are plugged.

China's dance with the market still has some way to go. Increasingly, it is China that is taking the lead while the market seems happy to follow.