In China, a proxy for yuan’s rise?

Under pressure to allow its undervalued currency to appreciate, China on Wednesday hinted at greater flexibility in determining the renminbi’s (RMB) value, echoing similar sentiments from the central bank a fortnight ago. But economists say that the real adjustments will come more by way of real exchange rate adjustments and price hikes, which effectively to an appreciation by proxy.

On Wednesday, China’s vice-foreign minister Zhang Zhijun said China would “increase the flexibility” of the RMB exchange rate “at a controllable level in the future… based on the market demand and with reference to a basket of currencies.”

That sentiment reflected the observations of the central bank, the People’s Bank of China (PBoC), in its report on monetary policy implementation, released earlier this month. The PBoC report, which had for the first time moved away from terminology that spoke of “stability” of the RMB, was widely seen as a signal of likely appreciation of the currency, which, critics say, is grossly undervalued. However, in subsequent comments, policymakers vehemently denied that an appreciation was imminent, much less so under “international pressure.”

Zhang repeated that formulation on Wednesday, and emphasised that China would “further work on the exchange rate policy on its own initiative and in a constructive and controllable manner.” His comments come ahead of a key meeting of the 12th China-European Union Summit scheduled next week in Nanjing in eastern China, where the subject of currency valuations is bound to come up.

Ever since the global recession intensified, China has pegged the RMB to the US dollar in order to protect its export sector, which remains badly affected. Critics say China’s policy is feeding global trade imbalances and impairing a nascent recovery, but not everyone agrees with that assessment.

“When it comes to the renminbi exchange rate, there are always intense debates as well as confusion,” says UBS economist Wang Tao. “Contrary to what many may believe, the renminbi has not depreciated against most (Asian) regional currencies since the onset of the financial crisis. This is because many regional currencies depreciated sharply against the US dollar in late 2008, when the RMB was held unchanged.”

In any case, she adds, “what really matters to the economy is the movement of real effective exchange rate —- that is, the trade weighted exchange rate movement relative to the price movements in China compared to trading partner countries.” In her estimation, the more relevant prices in the case of China, measuring the costs of tradable goods production, are probably producer prices.

According to Wang, while it is important to look at the RMB/USD rate, it is “more” important to look at “the trade weighted effective exchange rate, as well as the relative prices adjustments.” That’s because, she adds, a key source of the cost-competitiveness in China’s manufacturing goods is “the low costs of resource and energy, helped by various policy and implicit subsidies.”

Recently, electricity tariffs charged on industries was hiked by 5%, which, Wang says, is “as important a real exchange rate adjustment as a move in the nominal RMB/USD rate,” but which hasn’t received as much attention as exchange rate movements might have got.

“While the nominal rate may see very little movement in the coming year, the relative price adjustments could help to appreciate the real exchange rate, at least the rate the heavy industries are facing,” she adds.