HONG KONG: Economic policy circles in China and Hong Kong are abuzz with speculation that Chinese authorities are preparing for a one-off 10% appreciation of the renminbi later this year as a “shock treatment” procedure to rein in the country’s soaring trade surplus and beat back currency speculators.
Such a move, if implemented, would make China’s booming exports - the engines that drive the dragon economy, which is showing symptoms of overheating - relatively less competitive.
It would also echo a measure the Chinese authorities implemented in July 2005, when the renminbi was allowed to appreciate by 5%.
Since then, they have allowed the currency to appreciate gradually, but have repeatedly ruled out a significant revaluation, despite pressure from the US and Europe, which bear the brunt of China’s mounting trade surplus.
“The intriguing possibility that the authorities might be preparing for a second renminbi revaluation in the 10% range is gaining traction in policy circles,” notes UBS chief Asia economist Jonathan Anderson.
The logic behind such speculation, he says, is as follows: “it’s increasingly clear that the risks to China’s trade balance lie on the upside this year, which means that the current policies of trying to quell export growth and gradually let the renminbi strengthen are not ‘working’ as far as the external balance is concerned. And the prospect of letting the currency strengthen faster than the recent 6% to 8% pace is also fraught with risks, since stronger trend gains could easily begin to pull hot money back into the country, making life much more difficult for the People’s Bank of China (China’s central bank).”
In such an environment, he notes, policymakers may wonder: why not take a stronger one-off adjustment of 10% or even higher, thereby stemming the potential for currency speculation before it happens?
“In the current environment, it’s a small but rising possibility,” notes Anderson. However, he acknowledges, this is an “unlikely scenario” - not only because there isn’t sufficient political support for such a large discrete move but also because it’s not clear that carrying out another revaluation would solve China’s trade problem or end the currency speculation. In fact, adds Anderson, “our baseline forecast framework still looks for a structural turnaround in the trade balance by the end of this year.”
Earlier this month, authorities reported that China’s trade surplus last month shot up to $25 billion, against $19 billion in December 2006. Significantly, for the first time in China’s three-year history of rising trade balance, this jump came from faster export growth, rather than weaker imports.
Simultaneously, credit growth, which had been slowing throughout the second half of 2006, jumped by more than 2 percentage points in January and February - to the fastest pace since the 2003 real estate credit bubble.
On the face of it, says Anderson, this indicates that just as in late 2005, the economy is off to yet another strong reacceleration. Except that this time, CPI inflation is higher, the credit-pick-up is even sharper, and from all accounts, “the trade surplus appears to be spinning out of the authorities’ control.”
On Saturday, the People’s Bank of China announced an average 27 basis points (0.27 percentage point) hike in the commercial bank deposit interest rate ceiling and the lending rate floor across most maturities. This was the third time in 11 months that the central bank was raising rates in an attempt to rein in a runaway economy.
“The rate hike itself was widely expected, but the timing came as a surprise,” says Credit Suisse Asia economist Dong Tao. It also marks a departure from the “usual rituals” of using the reserve requirement ratio and open market operation as the main policy tools for managing domestic liquidity.
“We think Beijing wants to show its determination in controlling credit growth and to avoid negative interest rate by hiking rates now,” Tao adds.
Anderson, however, feels that the rate hike wil not have “any real macroeconomic impact”. The hike is “far too small to have any impact on credit demand, asset prices or real activity.”
Tao says he does not expect another rate hike in the next couple of months, but believes that administrative measures specifically targeting “aggressive lenders” are likely.
“Assuming no consecutive rate hikes and drastic austerity in the near future, we think this rate hike has limited impact on the economy.”